General Dynamics 10-K 2012
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2011
EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 1-3671
GENERAL DYNAMICS CORPORATION
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ü No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No ü
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 (or for such shorter period that the registrant was required to
file such reports), 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and
will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by
reference in Part III of this Form 10-K or any amendment of this Form 10-K. ü
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
The aggregate market value of the voting common equity held by non-affiliates of the registrant was $26,079,926,210 as of July 3, 2011
(based on the closing price of the shares on the New York Stock Exchange).
356,821,649 shares of the registrants common stock were outstanding on January 29, 2012.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III incorporates by reference information from certain portions of the registrants definitive proxy statement for the 2012 annual
meeting of shareholders to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year.
2 General Dynamics Annual Report 2011
(Dollars in millions, unless otherwise noted)
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; military and commercial shipbuilding; and communications and information technology. We and our subsidiaries employ 95,100 people globally. We foster a culture of ethical behavior and integrity that is evident in how we interact with shareholders, employees, customers, suppliers, partners and the communities in which we operate.
We strive to deliver consistently superior shareholder returns. Our experienced management team creates shareholder value through disciplined program execution, organic growth, margin improvement, efficient cash-flow conversion and prudent capital deployment. We seek to manage overhead costs, incentivize continuous-improvement initiatives and collaborate across our businesses to enhance margins. Our balanced capital deployment approach involves internal investment, acquisitions and divestitures, dividends and the repurchase of company shares on the open market. As an experienced incumbent on multiple core defense programs, our portfolio remains well-positioned. We also proactively pursue innovative product development in our core markets and new opportunities in adjacent markets.
Formed in 1952, General Dynamics grew organically and through acquisitions until the early 1990s, when we sold nearly all of our divisions except Electric Boat and Land Systems. Starting in the mid-1990s, we began expanding by acquiring combat vehicle-related businesses, additional shipyards, information technology product and service companies and Gulfstream Aerospace Corporation. Since, we have acquired and integrated over 60 businesses, including six in 2011, to further strengthen and complement our business portfolio.
General Dynamics is incorporated in Delaware. We operate through four business groups: Aerospace, Combat Systems, Marine Systems and Information Systems and Technology. For selected financial information regarding each of our business groups, see Note Q to the Consolidated Financial Statements contained in Part II, Item 8, of this Annual Report on Form 10-K.
Our Aerospace group designs, manufactures and outfits a comprehensive family of large- and mid-cabin Gulfstream business-jet aircraft, provides aircraft services (including maintenance and repair work, fixed-based operations (FBO) and aircraft management services) and performs aircraft completions for aircraft produced by other original equipment manufacturers (OEMs). With more than 50 years of experience at the forefront of the business-jet aviation market, the Aerospace group is known for:
The Gulfstream product line includes aircraft across a spectrum of price and performance options. The varying ranges, speeds and cabin dimensions are well-suited to the transportation needs of an increasingly diverse and global customer base. The large-cabin models are manufactured at Gulfstreams headquarters in Savannah, Georgia, while the mid-cabin models are constructed by an Israeli supplier. All models are outfitted in the groups U.S. facilities.
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The two newest aircraft to join the Gulfstream family are the ultra-large-cabin, ultra-high-speed G650 and the super-mid-size G280. The G650 has the longest range, fastest speed, largest cabin and most advanced cockpit in the Gulfstream fleet and defines a completely new segment at the top of the business-jet market. The G650 received Federal Aviation Administration (FAA) provisional type certification in the fourth quarter of 2011 with full type certification expected in mid-2012. The G280, which recently replaced the G200, offers a larger cabin and the longest range at the fastest speed in its class. During flight testing, the G280 exceeded the original performance expectations announced at the programs launch, including a 200-nautical-mile increase in range. The G280 has received Civil Aviation Administration of Israel (CAAI) provisional type certification with full FAA type certification expected in mid-2012. The G650 and the G280 are scheduled to enter service following full type certification.
While the installed base of aircraft is predominantly in North America, international customers represent approximately 65 percent of the groups backlog. Approximately 70 percent of the groups orders in 2011 were from international customers, with significant growth in orders in the Asia-Pacific region. Private companies and individual customers collectively represented approximately 60 percent of the groups total orders. Gulfstream also remains a leading provider of aircraft for government and military service around the world, with aircraft operated by nearly 40 nations. These government aircraft are used for head-of-state/executive transportation and a variety of special-mission applications, including aerial reconnaissance, maritime surveillance, weather research and astronaut training.
The Aerospace group remains committed to research and development (R&D). We continuously invest in R&D to introduce new products and first-to-market enhancements that broaden customer choice, improve aircraft performance and set new standards for customer safety, comfort and in-flight productivity. Gulfstreams aircraft are designed to minimize lifecycle costs while maximizing the commonality of parts among the various models. Current product-enhancement and development efforts include initiatives in advanced avionics, composites, flight-control systems, acoustics, cabin technologies and enhanced vision systems. Recent innovations include a state-of-the-art cabin management system for the G650, giving passengers control of the aircraft cabin systems through a handheld device that is synched to a particular seat on the aircraft. Each passenger can easily control their own environment, including lighting, temperature and entertainment equipment. We also recently launched a PlaneBook application, an electronic document management system that provides pilots easy and immediate access to critical flight information and aircraft-specific documents.
A $500 seven-year facilities expansion project is underway at Gulfstreams Savannah campus, including constructing new facilities, renovating existing infrastructure and expanding the groups R&D center. This investment is designed to ensure Gulfstream is well-positioned to meet future demand for business-jet aircraft and support services. This effort follows a recently completed $400 multi-year project in Savannah that established a purpose-built G650 manufacturing facility, increased aircraft-service capacity, improved the groups customer sales and design center and created a state-of-the-art paint facility.
In addition to the increased service capacity in Savannah, Gulfstreams service network continues to evolve to address the demands of the growing international installed base. In 2011, we continued to focus on increasing the groups international parts and materials inventory and adding personnel in fast-growing markets. In Asia, for example, Gulfstream opened a product support office in Hong Kong and a sales office in Beijing to support customers before, during and after their aircraft purchase. We also expanded service facilities in Westfield, Massachusetts; Dallas, Texas; Luton, England; and Madrid, Spain. Gulfstreams product support team deploys a team of aircraft technicians in support of urgent customer-service requirements in the Americas and Europe. This commitment to superior product support continues to receive industry recognition, including the number-one ranking for the ninth consecutive year in the annual Aviation International News Product Support Survey, as well as first-in-class product support recognition in the annual Professional Pilot survey.
We have leveraged the acquisition of Jet Aviation, a maintenance and repair services provider with aircraft service centers in more than 20 locations worldwide, to provide customers first-in-class service and support 24 hours a day. As a trusted provider of turnkey aircraft management and FBO services to a broad global customer base, Jet Aviation supports the continued growth and diversification of the Aerospace portfolio. Jet Aviation also performs aircraft completions for business jets and narrow- and wide-body commercial aircraft produced by other OEMs at locations in Europe and the United States.
A market leader in the business-aviation industry, the Aerospace group remains focused on:
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Revenues for the Aerospace group were 16 percent of our consolidated revenues in 2009 and 2010 and 19 percent in 2011. Revenues by major products and services were as follows:
Our Combat Systems group is a global leader in the design, development, production, support and enhancement of tracked and wheeled military vehicles, weapons systems and munitions for the United States and its allies. The groups product lines include:
We have a mature and diverse portfolio of franchise products that deliver core capabilities to domestic and international customers across the military-vehicle, weapons-system and munitions markets. These long-term production programs enable us to pursue continuous process improvements and other cost reduction initiatives that drive the groups financial performance. We apply our design and engineering expertise to develop product enhancements that advance the utility, safety and effectiveness of our products, while identifying and positioning for new opportunities.
Our portfolio of vehicle platforms consists of wheeled tactical and combat vehicles and main battle tanks, including the Stryker wheeled combat vehicle, the Abrams main battle tank and the Mine-Resistant, Ambush-Protected (MRAP) class of tactical vehicles. These vehicles are fundamental to the militarys warfighting capabilities and offer continuing opportunities for upgrades and modernization to meet evolving requirements.
The Stryker has proven itself as a versatile combat vehicle, supporting numerous missions with 10 variants. In addition to ongoing production of these vehicles, we continue to work to ensure the Stryker remains relevant, affordable and capable of operating in a dynamic threat environment. For example, the group recently developed a double-V-hulled Stryker vehicle designed to further enhance protection of the crew from improvised explosive devices (IEDs). Moving from concept to delivery in just 14 months, more than 320 double-V-hulled vehicles have been delivered. As a result of its successful fielding in Afghanistan, we received orders for production of nearly 300 additional double-V-hulled vehicles in 2011. Also, there is potential for double-V-hull conversions of previously delivered Stryker vehicles and additional new production.
We continue to support the Armys evolving needs for main battle tanks with technology upgrades to the Abrams, such as the System Enhancement Package (SEP). The SEP-configured tank is a digital platform with an enhanced command-and-control system, second-generation thermal sights and improved armor. We are also engaged in development efforts that can provide additional upgrade opportunities while increasing the efficiency and capability of the tank, which is planned to be a core Army platform for many decades.
Beyond these long-term platform programs, we have opportunities associated with the refurbishment of battle-damaged vehicles, the replacement of equipment that has reached the end of its service life and the replenishment of ammunition and other supplies for the U.S. armed forces. As the sole provider of Abrams tanks and Stryker vehicles, Combat Systems is the primary contractor for the maintenance, repair and reset of these vehicles.
We expanded the groups vehicle offerings through the recent acquisition of Force Protection, Inc., adding the Buffalo route clearance and the versatile Cougar vehicles to our portfolio. These vehicles are at the forefront of blast- and ballistic-protected technologies and are designed to protect their occupants from landmines, hostile fire and IEDs. In addition to the more than 4,500 RG-31 and Cougar vehicles delivered to the U.S. military under the MRAP program, the group also provides Cougar, Buffalo and Ocelot vehicles to foreign customers including the U.K. Ministry of Defence. This large installed base has led to subsequent modernization programs, as well as support and sustainment services.
Complementing these combat-vehicle offerings are Combat Systems weapons-systems and munitions programs. For ground forces, the group manufactures vehicle armor, M2 heavy machine guns and MK19 and MK47 grenade launchers. For airborne platforms, Combat Systems produces weapons for many foreign customers and for all U.S. fighter aircraft, including high-speed Gatling guns for fixed-wing aircraft and the Hydra-70 family of rockets. We are also a global manufacturer and supplier of composite aircraft and ground equipment components and highly engineered axles, suspensions, brakes and aftermarket parts for heavy-payload vehicles for a variety of military and commercial customers.
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The group holds leading munitions supply positions for products such as:
With the expertise from our incumbency on current production programs, we are well-positioned to participate in future U.S. vehicle development programs. In 2011, we were awarded one of two contracts to compete for the preliminary design and development of the Armys next-generation armored personnel carrier, the Ground Combat Vehicle (GCV). The group also intends to leverage its unique experience developing expeditionary vehicles to address the U.S. Marine Corps evolving approach to its amphibious-assault requirements. There are several new light vehicle opportunities in the domestic and international markets, including the Joint Light Tactical Vehicle (JLTV) program, which is intended to replace a portion of the U.S. fleet of High Mobility Multi-purpose Wheeled Vehicles (HMMWV). Additionally, the groups Robotic Systems business is a leader in tactical autonomous robotics and the command and control technology that manages autonomous systems.
Combat Systems has a significant presence internationally and is a recognized military-vehicle integrator and leading defense-materiel provider worldwide. The group has manufacturing facilities in Australia, Austria, Brazil, Canada, France, Germany, Spain and Switzerland. These operations are a key part of the defense industrial base of their home countries and have an extended customer base in more than 30 countries. The groups European operations offers a broad range of products, including light- and medium-weight tracked and wheeled tactical vehicles, amphibious bridge systems, artillery systems, light weapons, ammunition and propellants. Key platforms include the Leopard tank and the Pizarro tracked infantry vehicle; the EAGLE wheeled vehicle; and the Piranha and Pandur wheeled armored vehicles, which the group produces for several European, Middle Eastern and other international customers.
As a result of the demonstrated success of our fielded products, we have experienced continued international demand. The groups U.S. export activities include Abrams tanks and Light Armored Vehicles (LAVs) for U.S. allies in the Middle East. The group also is manufacturing tracked combat vehicle hulls for the Israeli Ministry of Defense, with deliveries scheduled to begin in 2012. Combat Systems leverages the customer relationships developed through its in-country operations around the world. For example, Combat Systems received a contract in 2011 from the Canadian government to modernize 550 LAV III combat vehicles at its London, Ontario, and Edmonton, Alberta, facilities, in addition to an existing contract to provide long-term support to all Canadian LAV vehicles. We will also co-produce the Specialist Vehicle for the U.K. Ministry of Defence with the United Kingdom operations of the companys Information Systems and Technology group. Additionally, deliveries began in 2011 of a variant of the Ocelot armored vehicle for the United Kingdom under the Light Protected Patrol Vehicle program.
The Combat Systems group continues to emphasize operational execution and business optimization initiatives to drive cost reductions as the group delivers on its backlog. Efforts undertaken in 2011 include the relocation of our European defense business headquarters to Madrid, Spain, and the consolidation of our guns and weapons businesses to align with anticipated demand, ensuring that we are competitively positioned for the future. In an environment of dynamic threats and evolving customer needs, the group remains focused on innovation, affordability and speed-to-market to secure new opportunities.
Revenues for the Combat Systems group were 30 percent of our consolidated revenues in 2009 and 27 percent in 2010 and 2011. Revenues by major products and services were as follows:
Our Marine Systems group designs, builds and supports submarines and surface ships. We are one of two primary shipbuilders for the U.S. Navy. The groups diverse portfolio of platforms and capabilities includes:
The substantial majority of Marine Systems workload supports the U.S. Navy. These efforts include the construction of new ships and the design and development of next-generation platforms to help the Navy meet evolving missions and maintain its desired fleet size. The group also provides maintenance, repair and modernization services to help maximize the life and effectiveness of in-service ships and maintain their relevance to the Navys current requirements. This business consists primarily of major ship-construction programs awarded under large, multi-ship
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contracts that span several years. The groups current Navy construction programs are the fast-attack Virginia-class nuclear-powered submarine, the Arleigh Burke-class (DDG-51) and Zumwalt-class (DDG-1000) guided-missile destroyers, and the Lewis and Clark-class (T-AKE) combat-logistics and Mobile Landing Platform (MLP) auxiliary support ships.
The Virginia-class submarine is the first U.S. submarine designed to address post-Cold War threats, including capabilities tailored for open-ocean and littoral missions. These stealthy boats are well-suited for a variety of global assignments, including intelligence gathering, special-operations missions and sea-based missile launch. The Virginia-class program includes 30 submarines, which the customer is procuring in multi-ship blocks. The group has delivered eight of 18 boats under contract in conjunction with an industry partner that shares in the construction of these vessels. The ninth boat in the class is expected to be delivered in the first quarter of 2012 in a record 62 months, three months faster than any of the previous boats in the program and an entire year earlier than original delivery projections. The remaining 10 boats under contract extend deliveries through 2018. Plans published by the Navy include a request for proposals in 2012 for nine submarines under a fourth block of the program. As a result of U.S. combatant-commander requirements for the versatile capabilities of the Virginia-class submarine, strong customer and congressional support, innovative cost-saving efforts and successful program performance, the group started construction of two submarines per year beginning in 2011.
We are the lead designer and producer of DDG-51s, the only active destroyer in the Navys global surface fleet. DDG-51s are multi-mission combatants that offer defense against a wide range of threats, including ballistic missiles. In 2011, we delivered the 33rd of 34 DDG-51 ships under the Navys legacy multi-ship contract. The remaining ship is scheduled for delivery in 2012. The group is also the lead DDG-51 design and planning shipyard, managing the design, modernization and lifecycle support of these ships. In the third quarter of 2011, in connection with the Navys restart of the DDG-51 program, the group was awarded a construction contract for a DDG-51 destroyer scheduled for delivery in 2016 and won a competitively awarded option for an additional destroyer.
In 2011, the group completed the detailed design of the next-generation guided-missile destroyer, the DDG-1000, and is building the first of the three ships in the class. In 2011, the group received an award for its portion of the construction of the second and third ships in the program. While the group is responsible for much of the construction of the ship, significant components will be manufactured by others and supplied as government-furnished material for integration into the destroyer. Delivery of the ships is scheduled for 2014, 2015 and 2018.
The groups T-AKE combat-logistics ship supports multiple missions for the Navy, including replenishment at sea for U.S. and NATO operating forces around the world. T-AKE is the first Navy ship to incorporate proven commercial marine technologies like integrated electric-drive propulsion. These technologies are designed to minimize T-AKE operations and maintenance costs over an expected 40-year life. The group has delivered 12 ships under the 14-ship program, including two in 2011. Work is underway on the remaining two ships, which are scheduled for delivery in 2012. Over the course of the program, the group has reduced the hours required to build a single ship by more than 60 percent, completing construction of the 12th ship in half the scheduled time required to build the first.
In 2011, the group was awarded contracts for construction of the first two ships in the MLP program and long-lead funding for the third ship. Construction of the first ship commenced in 2011, with delivery scheduled in 2013. The MLP is an auxiliary support ship intended to serve as a floating transfer station, improving the Navys ability to deliver equipment and cargo to areas without adequate port access.
The group is also developing new technologies and naval platforms. These design and engineering efforts include initial concept studies for the development of the next-generation ballistic-missile submarine (SSBN(X)), which is expected to replace the current Ohio Class of ballistic missile submarines. The group is participating in the design of the SSBN Common Missile Compartment under development for the U.S. Navy and the Royal Navy of the United Kingdom with significant contract awards received in 2011 to continue this development.
In addition to these design and construction programs, Marine Systems provides comprehensive ship and submarine overhaul, repair and lifecycle support services to extend the service life of these vessels and maximize the value of these ships to the customer. We operate the only full-service maintenance and repair shipyard on the West Coast. In 2011, the group acquired Metro Machine Corp., a surface-ship repair operation located in Norfolk, Virginia, enhancing our ability to deliver maintenance and repair services to the Atlantic and Pacific fleets. We also provide allied navies with program management, planning, engineering and design support for submarine and surface-ship construction programs.
Marine Systems has the proven capability to design and produce ships for commercial customers to meet the Jones Act requirement that ships carrying cargo between U.S. ports be built in U.S. shipyards. For example, in 2010 the group delivered the final ship in a five-ship commercial product-carrier program. Given the success of this program, the age of the fleet of Jones Act ships and environmental regulations that require double-hull tankers and impose emission control limits, we anticipate additional commercial shipbuilding opportunities.
To further the groups goals of efficiency, affordability for the customer and continuous improvement, we make strategic investments in our business, often in cooperation with the Navy and local governments. In addition, Marine Systems leverages its design and engineering expertise across its shipyards to improve program execution and generate cost savings. This knowledge sharing enables the group to use resources more efficiently and drive process improvements. We are well-positioned to fulfill the ship-construction and support requirements of our Navy and commercial customers.
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Revenues for the Marine Systems group were 20 percent of our consolidated revenues in 2009, 21 percent in 2010 and 20 percent in 2011. Revenues by major products and services were as follows:
INFORMATION SYSTEMS AND TECHNOLOGY
Our Information Systems and Technology group provides critical technologies, products and services that support a wide range of government and commercial communication and information-sharing needs. The group consists of a three-part portfolio centered on tactical communication systems, information technology and related services and intelligence, surveillance and reconnaissance systems.
Tactical communication systems We design, manufacture and deliver secure communications systems, command-and-control systems and operational hardware to customers within the U.S. Department of Defense (DoD), the intelligence community and federal civilian agencies, and to international customers. Our leadership in this market results from decades of domain expertise with legacy systems, incumbency on todays programs and continuous innovation that encompasses key technologies at the center of our customers missions. The groups solutions include:
This market is characterized by programs that enhance the warfighters ability to communicate, collaborate and access vital information through high-bandwidth, on-the-move Internet-like battlefield networks. Key programs include the U.S. Armys Warfighter Information Network-Tactical (WIN-T) and the Joint Tactical Radio System (JTRS).
WIN-T is the Armys primary battlefield communications network. As the prime contractor, we are responsible for the design, engineering, integration, production, program management and support of the network. Using ground and satellite communications links, WIN-T provides commanders with the digital communications services they need to access intelligence information, collaborate with other military elements, issue orders and monitor their forces. We have deployed the first increment of WIN-T to more than 90 percent of the U.S. Army. The second increment of WIN-T, which adds on-the-move command and control and other capabilities, is in low-rate initial production. The third increment will provide enhanced network reliability, increased capacity and smaller, more-tightly integrated communications and networking gear.
The JTRS program will provide communications among all U.S. military branches on multi-channel, software-defined radios. We are developing the JTRS Handheld, Manpack, Small Form Fit (HMS) network radios to connect individual soldiers, sensors and robotic platforms. These small radios have secure, mobile voice, video and data communications capabilities that are similar to those available through commercial cellular networks. The JTRS HMS radios are the first ground-domain radios fielded by the U.S. military that meet the full suite of JTRS requirements. The Army authorized low-rate production of over 6,000 radios in 2011, and initial Army plans call for purchasing more than 240,000 HMS radios.
Information Systems and Technology delivers similar modern communications and information-sharing benefits to many federal civilian customers, including the U.S. Department of Homeland Security. For example, we are the prime contractor for the U.S. Coast Guards Rescue 21 system, an enhanced command, control and communications system used to monitor distress calls along nearly 40,000 miles of U.S. coastline and to coordinate search-and-rescue response. Additionally, for the National Aeronautics and Space Administration (NASA), we are implementing a new ground-system architecture that improves the agencys space-to-ground telecommunications and tracking coverage.
We provide many of these capabilities to non-U.S. customers, including the U.K. Ministry of Defence, the Canadian Department of National Defence and public agencies and private companies in Europe and the Middle East. In 2010, for example, we were selected to provide the telecommunications and security systems for the Khalifa Port in the United Arab Emirates. The $100 project includes design, procurement, integration and installation of the ports telecommunications, security and control systems, helping to make it among the most technologically advanced ports in the world once completed.
Information technology services We provide mission-critical information technology (IT) and highly specialized mission-support services to the U.S. defense and intelligence communities; the Departments of Homeland Security, Health and Human Services and other federal civilian agencies; and commercial and international customers. We specialize in:
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In this market, Information Systems and Technology has a long-standing reputation for excellence in providing technical-support personnel and domain specialists, many of whom possess high-level clearances, to help customers execute their missions effectively. Frequently, our employees are the on-call staff that provides technical support for commercial desktop technology and mission-specific hardware. For example, we operate approximately 20 security operations centers and 15 critical incident response teams. Our employees also develop, install and operate mission systems on a daily basis.
Information Systems and Technology supplies network-modernization and IT infrastructure services to U.S. government customers. We are deploying a turnkey IT network infrastructure for the new 1.7 million square-foot Mark Center facility, located in the Washington, D.C. region, where 6,400 employees from 11 DoD organizations are relocating. We also will provide full enterprise support in relocating the Department of Homeland Securitys headquarters to the St. Elizabeths campus, including establishing a state-of-the-art IT infrastructure.
In addition, we are a leading provider of IT solutions that meet the fast-growing needs for technology modernization of government and commercial healthcare organizations. In 2011, we acquired Vangent, Inc., which, combined with our existing health IT business, created a Tier 1-level business that meets the large-scale requirements of customers in this growing market. The groups combined offerings include data management, analytics, fraud prevention and detection software, decision support and process automation solutions. Programs include support for the Armys military health IT mission by providing accurate and timely information to medical staff in the field and at treatment facilities that helps ensure continuity of care for injured soldiers. For the Centers for Medicare & Medicaid Services, we are supporting the governments implementation of healthcare reform and medical benefits programs by delivering an automated Medicare claim adjudication system that efficiently manages the large volume of medical and healthcare claims. We also provide critical citizen services, including administration of the 1-800-MEDICARE contact line and several services that support U.S. student loan processing and administration.
Intelligence, surveillance and reconnaissance systems We provide mission-related systems development, integration and operations support to customers in the U.S. defense, intelligence and homeland security communities, and to U.S. allies. These offerings include:
Information Systems and Technologys experience in securing and protecting government organizations from network attacks has resulted in a market-leading position in cyber security. We are the principal support contractor for the Department of Homeland Securitys U.S. Computer Emergency Readiness Team (US-CERT), which provides defense against and response support to cyber attacks for U.S. executive branch agencies and information sharing and collaboration with state and local government, industry and international partners. The group also uses its expertise to provide services to commercial victims of cyber attacks, including retail and financial services firms. Working closely with federal law enforcement and regulatory agencies, we provide investigative and forensic expertise as well as network remediation services.
Information Systems and Technology has a 50-year legacy of providing advanced fire control systems for Navy submarine programs and currently is developing and integrating commercial off-the-shelf (COTS) software and hardware upgrades to improve the tactical control capabilities for several submarine classes. This initiative leads the implementation of the Navys open architecture and open business model approach on submarines with a design that emphasizes shared standards, providing greater interoperability, scalability and supplier independence. Capitalizing on this expertise and open architecture approach, we developed the combat and seaframe control systems for the Navys Independence Class of Littoral Combat Ships (LCS) and it is the ship mission systems integrator on the Joint High Speed Vessel (JHSV) program for the Navy.
Opportunities in the groups three principal markets continue to be driven by the expanding needs of our diverse customer base, including:
Revenues for the Information Systems and Technology group were 34 percent of our consolidated revenues in 2009, 36 percent in 2010 and 34 percent in 2011. Revenues by major products and services were as follows:
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In 2011, 69 percent of our revenues were from the U.S. government; 12 percent were from U.S. commercial customers; 9 percent were from international defense customers; and the remaining 10 percent were from international commercial customers.
Our primary customers are the DoD and the U.S. intelligence community. We also contract with other U.S. government customers, including the Department of Homeland Security, Department of Health and Human Services, Centers for Medicare & Medicaid Services and several first-responder agencies. Our revenues from the U.S. government were as follows:
We perform our U.S. government business under fixed-price, cost-reimbursement and time-and-materials contracts. Our production contracts are primarily fixed-price. Under these contracts, we agree to perform a specific scope of work for a fixed amount. Contracts for research, engineering, repair and maintenance and other services are typically cost-reimbursement or time-and-materials. Under cost-reimbursement contracts, the customer reimburses contract costs and pays a fixed fee or an incentive- or award-based fee. These fees are determined by our ability to achieve targets set in the contract, such as cost, quality, schedule and performance. Under time-and-materials contracts, the customer pays a fixed hourly rate for direct labor and reimburses us for material costs.
Fixed-price contracts accounted for approximately 55 percent of our U.S. government business in 2010 and 2011; cost-reimbursement contracts accounted for approximately 39 percent in 2010 and 38 percent in 2011; and time-and-materials contracts accounted for approximately 6 percent in 2010 and 7 percent in 2011.
Each of these contract types presents advantages and disadvantages. Fixed-price contracts typically have higher fee levels as we assume more risks, such as cost overruns. Therefore, these types of contracts offer additional profits if we can complete the work for less than the contract amount. Cost-reimbursement contracts generally subject us to lower risk. Accordingly, the negotiated base fees are generally lower than on fixed-price contracts. Cost-reimbursement contracts also can include fee provisions that allow the customer to make additional payments when we satisfy certain performance criteria. However, not all costs are reimbursed under these types of contracts and the government carefully reviews the costs we charge. Under time-and-materials contracts, our profit may vary if actual labor-hour costs vary significantly from the negotiated rates. Additionally, because we often charge material costs with little or no fee, the content mix can impact the profit margins associated with these contracts.
Our U.S. commercial revenues were $3.3 billion in 2009, $3.2 billion in 2010 and $3.8 billion in 2011. This represented approximately 10 percent of our consolidated revenues in 2009 and 2010 and 12 percent in 2011. The majority of these revenues are for business-jet aircraft where our customer base consists of individuals and public and privately held companies representing a wide range of industries. Other commercial products include drivetrain components and aftermarket parts in our Combat Systems group, Jones Act ships in our Marine Systems group and a variety of products and services in our Information Systems and Technology group.
Our direct revenues from government and commercial customers outside the United States were $6 billion in 2009 and 2010 and $6.3 billion in 2011. This represented approximately 19 percent of our consolidated revenues in 2009, 18 percent in 2010 and 19 percent in 2011.
We conduct business with government customers around the world with primary subsidiary operations in Australia, Austria, Brazil, Canada, France, Germany, Italy, Mexico, Spain, Switzerland and the United Kingdom. Our non-U.S. defense subsidiaries are committed to maintaining long-term relationships with their respective governments and have distinguished themselves as principal regional suppliers and employers.
Our international commercial business consists primarily of business-jet aircraft exports and worldwide aircraft services. The market for business-jet aircraft and related services outside North America has expanded significantly in recent years, particularly in emerging markets, including the Asia-Pacific region. While the installed base of aircraft is concentrated in North America, orders from international customers represent a growing segment of our aircraft business with approximately 70 percent of total orders and 65 percent of total backlog in 2011.
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For a discussion of the risks associated with conducting business in international locations, see Risk Factors contained in Part I, Item 1A, of this Annual Report on Form 10-K. For information regarding sales and assets by geographic region, see Note Q to the Consolidated Financial Statements contained in Part II, Item 8, of this Annual Report on Form 10-K.
Several factors determine our ability to compete successfully in the defense and business-aviation markets. While customers evaluation criteria vary, the principal competitive elements include:
The U.S. government contracts with numerous domestic and foreign companies for products and services. We compete against other large platform and system-integration contractors as well as smaller companies that specialize in a particular technology or capability. Internationally, we compete with global defense contractors exports and the offerings of private and state-owned defense manufacturers based in the countries where we operate. Our Combat Systems group competes with a large number of domestic and foreign businesses. Our Marine Systems group has one primary competitor, Huntington Ingalls Industries, with which it also partners on the Virginia-class submarine program. Our Information Systems and Technology group competes with many companies, from large defense companies to small niche competitors with specialized technologies. The operating cycle of many of our major platform programs can result in sustained periods of program continuity when we perform successfully.
We are involved in teaming and subcontracting relationships with some of our competitors. Competitions for major defense programs often require companies to form teams to bring together broad capabilities to meet the customers requirements. Opportunities associated with these programs include roles as the programs integrator, overseeing and coordinating the efforts of all participants on the team, or as a provider of a specific program component or subsystem element.
Another competitive factor in the defense market is the U.S. governments use of indefinite delivery, indefinite quantity (IDIQ) contracts to provide customers with flexible procurement options. A common type of IDIQ contract known as a multiple-award contract allows the government to select a group of eligible contractors for a program and establish an overall spending limit. When the government awards IDIQ contracts to multiple bidders under the same program, we must compete subsequently for individual delivery orders. The IDIQ contracting model is most common among our Information Systems and Technology groups customers but also is being used in programs for which our Combat Systems group competes.
BUSINESS-JET AIRCRAFT MARKET
Gulfstream has several competitors for each of its products, with more competitors for the shorter-range aircraft. Key competitive factors include aircraft safety, reliability and performance; comfort and in-flight productivity; service quality, global footprint and responsiveness; technological and new-product innovation; and price. We believe Gulfstream competes effectively in all of these areas.
The Aerospace group competes worldwide in its business-jet aircraft services business primarily on the basis of price, quality and timeliness. In its maintenance and repair and FBO businesses, the group competes with several other large companies as well as a number of smaller companies, particularly in the maintenance business. In its completions business, the group competes with other OEMs, as well as third-party providers.
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Our total backlog represents the estimated remaining sales value of work to be performed under firm contracts and includes funded and unfunded portions. For additional discussion of backlog, see Managements Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7, of this Annual Report on Form 10-K.
Summary backlog information for each of our business groups follows:
RESEARCH AND DEVELOPMENT
To foster innovative product development and evolution, we conduct sustained R&D activities as part of our normal business operations. In the commercial sector, most of our Aerospace groups R&D activities support Gulfstreams product enhancement and development programs. In our defense businesses, we conduct customer-sponsored R&D activities under U.S. government contracts and company-sponsored R&D. In accordance with government regulations, we recover a significant portion of company-sponsored R&D expenditures through overhead charges to U.S. government contracts. For more information on our R&D activities, including our expenditures for the past three years, see Note A to the Consolidated Financial Statements contained in Part II, Item 8, of this Annual Report on Form 10-K.
We develop technology, manufacturing processes and systems-integration practices. In addition to owning a large portfolio of proprietary intellectual property, we license some intellectual property rights to and from others. The U.S. government holds licenses to many of our patents developed in the performance of U.S. government contracts, and it may use or authorize others to use the inventions covered by these patents. Although these intellectual property rights are important to the operation of our business, no existing patent, license or other intellectual property right is of such importance that its loss or termination would, in our opinion, have a material impact on our business.
On December 31, 2011, we and our subsidiaries had 95,100 employees, one-fifth of whom work under collective agreements with various labor unions and worker representatives. Agreements covering approximately 5 percent of total employees are due to expire in 2012. Historically, we have renegotiated labor agreements without any significant disruption to operating activities.
RAW MATERIALS, SUPPLIERS AND SEASONALITY
We depend on suppliers and subcontractors for raw materials, components and subsystems. These supply networks can experience price fluctuations and capacity constraints, which can put pressure on our costs. Effective management and oversight of suppliers and subcontractors is an important element of our successful performance. We attempt to mitigate these risks with our suppliers by entering into long-term agreements and leveraging company-wide agreements to achieve economies of scale, and by negotiating flexible pricing terms in our customer contracts. We have not experienced, and do not foresee, significant difficulties in obtaining the materials, components or supplies necessary for our business operations.
Our business is not generally seasonal in nature. The timing of contract awards, the availability of funding from the customer, the incurrence of contract costs and unit deliveries are the primary drivers of our revenue recognition. In the United States, these factors are influenced by the federal governments budget cycle. Internationally, work for many of our government customers is weighted toward the end of the calendar year, resulting in increasing revenues and earnings over the course of the year.
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U.S. GOVERNMENT CONTRACTS
U.S. government contracts are subject to procurement laws and regulations. The Federal Acquisition Regulation (FAR) and the Cost Accounting Standards (CAS) govern the majority of our contracts. The FAR mandates uniform policies and procedures for U.S. government acquisitions and purchased services. Also, individual agencies can have acquisition regulations that provide implementing language for the FAR or that supplement the FAR. For example, the Department of Defense implements the FAR through the Defense Federal Acquisition Regulation supplement (DFARs). For all federal government entities, the FAR regulates the phases of any product or service acquisition, including:
In addition, the FAR addresses the allowability of our costs, while the CAS address how those costs can be allocated to contracts. The FAR subjects us to audits and other government reviews covering issues such as cost, performance and accounting practices relating to our contracts.
Our international sales are subject to the applicable foreign government regulations and procurement policies and practices, as well as U.S. policies and regulations, such as the Foreign Corrupt Practices Act (FCPA). We are also subject to regulations governing investments, exchange controls, repatriation of earnings and import-export control, including the International Traffic in Arms Regulations (ITAR).
The Aerospace group is subject to FAA regulation in the United States and other similar aviation regulatory authorities internationally, including the Civil Aviation Administration of Israel (CAAI) and the European Aviation Safety Agency (EASA). For an aircraft to be manufactured and sold, the model must receive a type certificate from the appropriate aviation authority and each aircraft must receive a certificate of airworthiness. Often, aircraft receive provisional type certification prior to receiving full type certification. Aircraft outfitting and completions also require approval by the appropriate aviation authority, which often is accomplished through a supplemental type certificate. Aviation authorities can require changes to a specific aircraft or model type before granting approval. Maintenance facilities and charter operations must be licensed by aviation authorities as well.
We are subject to a variety of federal, state, local and foreign environmental laws and regulations. These laws and regulations cover the discharge, treatment, storage, disposal, investigation and remediation of some materials, substances and wastes. We are directly or indirectly involved in environmental investigations or remediation at some of our current and former facilities and at third-party sites that we do not own but where we have been designated a Potentially Responsible Party (PRP) by the U.S. Environmental Protection Agency or a state environmental agency. As a PRP, we potentially are liable to the government or third parties for the full cost of remediating contamination at a relevant site. In cases where we have been designated a PRP, generally we seek to mitigate these environmental liabilities through available insurance coverage and by pursuing appropriate cost-recovery actions. In the unlikely event we are required to fully fund the remediation of a site, the current statutory framework would allow us to pursue contributions from other PRPs. We regularly assess our compliance status and management of environmental matters.
Operating and maintenance costs associated with environmental compliance and management of contaminated sites are a normal, recurring part of our operations. Historically, these costs have not been material. Environmental costs often are recoverable under our contracts with the U.S. government. Based on information currently available and current U.S. government policies relating to cost recovery, we do not expect continued compliance with environmental regulations to have a material impact on our results of operations, financial condition or cash flows. For additional information relating to the impact of environmental matters, see Note N to the Consolidated Financial Statements contained in Part II, Item 8, of this Annual Report on Form 10-K.
We file several types of reports and other information with the Securities and Exchange Commission (SEC) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. These reports and information include an annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statements. Free copies of these items are made available on our website (www.generaldynamics.com) as soon as practicable and through the General Dynamics investor relations office at (703) 876-3152.
These items also can be read and copied at the SECs Public Reference Room at 100 F Street, N.E., Washington, DC 20549. Information on the operation of the Public Reference Room is available by calling the SEC at (800) SEC-0330. The SEC maintains a website (www.sec.gov) that contains reports, proxy and information statements, and other information.
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ITEM 1A. RISK FACTORS
An investment in our common stock or debt securities is subject to risks and uncertainties. Investors should consider the following factors, in addition to the other information contained in this Annual Report on Form 10-K, before deciding whether to purchase our securities.
Investment risks can be market-wide as well as unique to a specific industry or company. The market risks faced by an investor in our stock are similar to the uncertainties faced by investors in a broad range of industries. There are some risks that apply more specifically to our business.
Because three of our four business groups serve the defense market, our revenues are concentrated with the U.S. government. This customer relationship involves certain unique risks. In addition, our sales to international customers expose us to different financial and legal risks. In our Aerospace group, we face risks tied to U.S. and global economic conditions. Despite the varying nature of our U.S. and international defense and business-aviation operations and the markets they serve, each group shares some common risks, such as the ongoing development of high-technology products and the price, availability and quality of commodities and subsystems.
We depend on the U.S. government for a significant portion of our revenues. In each of the past three years, more than two-thirds of our revenues were from the U.S. government. U.S. defense spending has been driven by perceived threats to national security. While the country has been under an elevated threat level for the past decade, competing demands for federal funds could pressure all areas of spending.
A decrease in U.S. government defense spending or changes in spending allocation could result in one or more of our programs being reduced, delayed or terminated. Reductions in our existing programs could adversely affect our future revenues and earnings. For additional information relating to the current U.S. defense budget, see the Business Environment section of Managements Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7, of this Annual Report on Form 10-K.
U.S. government contracts are not always fully funded at inception and are subject to termination. Our U.S. government revenues are funded by agency budgets that operate on an October-to-September fiscal year. In February of each year, the President of the United States presents to the Congress the budget for the upcoming fiscal year. This budget proposes funding levels for every federal agency and is the result of months of policy and program reviews throughout the Executive branch. For the remainder of the year, the appropriations and authorization committees of the Congress review the Presidents budget proposals and establish the funding levels for the upcoming fiscal year. Once these levels are enacted into law, the Executive Office of the President administers the funds to the agencies.
There are two primary risks associated with the U.S. government budget cycle. First, the annual process may be delayed or disrupted. For example, changes in congressional schedules due to elections or other legislative priorities, or negotiations for program funding levels can interrupt the process. If the annual budget is not approved by the end of the government fiscal year, portions of the U.S. government can shut down or operate under a continuing resolution that funds spending at prior year levels, which can impact funding for our programs and timing of new awards. Additionally, the Congress typically appropriates funds on a fiscal-year basis, even though contract performance may extend over many years. Future revenues under existing multi-year contracts are conditioned on the continuing availability of congressional appropriations. Changes in appropriations in subsequent years may impact the funding available for these programs. Delays or changes in funding can impact the timing of available funds or lead to changes in program content.
In addition, U.S. government contracts generally permit the government to terminate a contract, in whole or in part, for convenience. If a contract is terminated for convenience, a contractor usually is entitled to receive payments for its allowable costs and the proportionate share of fees or earnings for the work performed. The government may also terminate a contract for default in the event of a breach by the contractor. If a contract is terminated for default, the government in most cases pays only for the work it has accepted. The loss of anticipated funding or the termination of multiple or large programs could have an adverse effect on our future revenues and earnings.
We are subject to audit by the U.S. government. U.S. government agencies routinely audit and investigate government contractors. These agencies review a contractors performance under its contracts and compliance with applicable laws, regulations and standards. The U.S. government also reviews the adequacy of, and a contractors compliance with, its internal control systems and policies, including the contractors purchasing, property, estimating, labor, accounting and information systems. In some cases, audits may result in costs not being reimbursed or subject to repayment. If an audit or investigation were to result in allegations of improper or illegal activities, we could be subject to civil or criminal penalties and administrative sanctions, including termination of contracts, forfeiture of profits, suspension of payments, fines, and suspension or prohibition from doing business with the U.S. government. In addition, we could suffer reputational harm if allegations of impropriety were made against us.
Our Aerospace group is subject to changing customer demand for business aircraft. Our Aerospace groups business-jet market is driven by the demand for business-aviation products and services by business, individual and government customers in the United States and around the world. The groups future results also depend on other factors, including general economic conditions, the availability of credit and trends in capital goods markets. If customers default on existing contracts and we are unable to replace those contracts, the groups anticipated revenues and profitability could be reduced as a result.
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Our earnings and margins depend on our ability to perform under our contracts. When agreeing to contractual terms, our management team makes assumptions and projections about future conditions or events. These projections assess:
If there is a significant change in one or more of these circumstances or estimates, or if we fail to adequately manage the risks under our contracts, the profitability of our contracts may be adversely affected. This could affect our earnings and margins.
Our earnings and margins depend in part on subcontractor and vendor performance. We rely on other companies to provide materials, components and subsystems for our products. Subcontractors also perform some of the services that we provide to our customers. We depend on these subcontractors and vendors to meet our contractual obligations in full compliance with customer requirements. We often rely on only one or two sources of supply that, if disrupted, could have an adverse effect on our ability to meet our commitments to customers. Our ability to perform our obligations as a prime contractor may be adversely affected if one or more of these suppliers is unable to provide the agreed-upon supplies or perform the agreed-upon services in a timely and cost-effective manner.
International sales and operations are subject to greater risks that sometimes are associated with doing business in foreign countries. Our international business may pose different risks than our business in the United States. In some countries there is increased chance for economic, legal or political changes. Government customers in newly formed free-market economies typically have procurement procedures that are less mature, which may complicate the contracting process. In this context, our international business may be sensitive to changes in a foreign governments leadership, national priorities and budgets. International transactions can involve increased financial and legal risks arising from foreign exchange-rate variability and differing legal systems. In addition, some international government customers require contractors to agree to specific in-country purchases, manufacturing agreements or financial support arrangements, known as offsets, as a condition for a contract award. The contracts may include penalties if we fail to meet the offset requirements. An unfavorable event or trend in any one or more of these factors could adversely affect our revenues and earnings associated with our international business.
Our future success depends, in part, on our ability to develop new products and technologies and maintain a qualified workforce to meet the needs of our customers. Many of the products and services we provide involve sophisticated technologies and engineering, with related complex manufacturing and system integration processes. Our customers requirements change and evolve regularly. Accordingly, our future performance depends, in part, on our ability to continue to develop, manufacture and provide innovative products and services and bring those offerings to market quickly at cost-effective prices. Because of the highly specialized nature of our business, we must hire and retain the skilled and qualified personnel necessary to perform the services required by our customers. If we are unable to develop new products that meet customers changing needs or successfully attract and retain qualified personnel, our future revenues and earnings may be adversely affected.
We have made and expect to continue to make investments, including acquisitions and joint ventures, that involve risks and uncertainties. These activities, particularly in the current environment of increased government regulation and enforcement domestically and abroad, may expose us to legal and regulatory risks that are different from the risks we have experienced in our existing businesses. When evaluating potential mergers and acquisitions, we make judgments regarding the value of business opportunities, technologies and other assets and the risks and costs of potential liabilities based on information available to us at the time of the transaction. Whether we realize the anticipated benefits from these transactions depends on multiple factors, including our integration of the businesses involved, the performance of the underlying products, capabilities or technologies and market conditions following the acquisition. Although we believe we have established appropriate procedures and processes to mitigate these risks and have a proven track record of successful acquisitions and investments, unanticipated performance issues and acquired liabilities associated with these activities could adversely affect our financial results, including future charges for impairment of long-lived assets.
Our business could be negatively impacted by cyber security events and other disruptions. As a defense contractor, we face various cyber security threats, including threats to our information technology infrastructure and attempts to gain access to our proprietary or classified information, as well as threats to physical security. We also design and manage information technology systems for various customers. We generally face the same security threats for these systems as for our own. Accordingly, we maintain information security policies and procedures for managing all systems. If any of these threats materialize, the event could cause serious harm to our business, damage our reputation and prevent us from being eligible for future work on sensitive or classified systems for U.S. government customers and could have an adverse effect on our results of operations.
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This Annual Report on Form 10-K contains forward-looking statements that are based on managements expectations, estimates, projections and assumptions. Words such as expects, anticipates, plans, believes, scheduled, outlook, estimates, should and variations of these words and similar expressions are intended to identify forward-looking statements. These include but are not limited to projections of revenues, earnings, operating margins, segment performance, cash flows, contract awards, aircraft production, deliveries and backlog. Forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict. Therefore, actual future results and trends may differ materially from what is forecast in forward-looking statements due to a variety of factors, including, without limitation, the risk factors discussed in this section.
All forward-looking statements speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document. All subsequent written and oral forward-looking statements attributable to General Dynamics or any person acting on our behalf are qualified by the cautionary statements in this section. We do not undertake any obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date of this report.
ITEM 2. PROPERTIES
We operate in a number of offices, manufacturing plants, laboratories, warehouses and other facilities in the United States and abroad. We believe our main facilities are adequate for our present needs and, given planned improvements and construction, expect them to remain adequate for the foreseeable future.
On December 31, 2011, our business groups had operations at the following locations:
A summary of floor space by business group on December 31, 2011, follows:
ITEM 3. LEGAL PROCEEDINGS
For information relating to legal proceedings, see Note N to the Consolidated Financial Statements contained in Part II, Item 8, of this Annual Report on Form 10-K.
ITEM 4. MINE SAFETY DISCLOSURES
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ITEM 5. MARKET FOR THE COMPANYS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is listed on the New York Stock Exchange.
The high and low sales prices of our common stock and the cash dividends declared on our common stock for each quarter of 2010 and 2011 are included in the Supplementary Data contained in Part II, Item 8, of this Annual Report on Form 10-K.
On January 29, 2012, there were approximately 13,000 holders of record of our common stock.
For information regarding securities authorized for issuance under our equity compensation plans, see Note O to the Consolidated Financial Statements contained in Part II, Item 8, of this Annual Report on Form 10-K.
We did not make any unregistered sales of equity securities in 2011.
On October 5, 2011, the board of directors authorized management to repurchase up to 10 million shares of common stock on the open market. We did not repurchase any shares in the fourth quarter. Unless terminated or extended earlier by resolution of the board of directors, the program will expire when the number of authorized shares has been repurchased.
For additional information relating to our repurchases of common stock during the past three years, see Financial Condition, Liquidity and Capital Resources Financing Activities Share Repurchases contained in Part II, Item 7, of this Annual Report on Form 10-K.
The following performance graph compares the cumulative total return to shareholders on our common stock, assuming reinvestment of dividends, with similar returns for the Standard & Poors® 500 Index and the Standard & Poors® Aerospace & Defense Index, both of which include General Dynamics.
General Dynamics Annual Report 2011 17
ITEM 6. SELECTED FINANCIAL DATA
The following table presents selected historical financial data derived from the audited Consolidated Financial Statements and other company information for each of the five years presented. This information should be read in conjunction with Managements Discussion and Analysis of Financial Condition and Results of Operations and the audited Consolidated Financial Statements and the Notes thereto.
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(Dollars in millions, except per-share amounts or unless otherwise noted)
ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
For an overview of our business groups, including a discussion of products and services provided, see the Business discussion contained in Part I, Item 1, of this Annual Report on Form 10-K.
The nations engagement in combating threats to U.S. national security around the world, coupled with the need to equip and modernize U.S. military forces, drives Department of Defense (DoD) funding requirements. As a defense contractor, our financial performance is impacted by the allocation and prioritization of U.S. defense spending. Procurement and research and development (R&D) budgets, also known as investment accounts, provide the majority of our U.S. defense revenues.
For fiscal year (FY) 2012, the DoD received funding of $531 billion, including approximately $177 billion for procurement and R&D. This funding was approximately $22 billion less than the Presidents FY 2012 request due to the Budget Control Act (BCA) of 2011. The BCA, which became law in August 2011, has two primary parts. The first mandates a $487 billion reduction to previously-planned defense spending over the next decade. The second part is a sequester mechanism that would impose an additional $500 billion of cuts on defense funding between FY 2013 and FY 2021 if the Congress does not identify a means to reduce the U.S. deficit by $1.2 trillion. As of February 17, 2012, the Congress has not identified these required savings. If the Congress does not identify the required reduction, defense spending would likely sustain further cuts.
For FY 2013, the President has requested total defense funding of $525 billion, including $168 billion for investment accounts. In accordance with the first part of the BCA, the DoDs five-year spending plan submitted with the FY 2013 funding request incorporates $259 billion of cuts when compared with the previous five-year plan. However, the spending plan does not include the impact of sequestration, the second part of the BCA. Despite these additional cuts, investment accounts are projected to display modest growth throughout the five-year period, with procurement funding for mature programs growing and R&D funding for development programs declining over the period.
Budget expenditures lag congressional funding, with appropriated money generally awarded over several years. A series of continuing resolutions over the past year has resulted in a protracted customer acquisition cycle that negatively impacted the flow of contract awards, particularly in our shorter-cycle Information Systems and Technology business group. The threat of further defense spending cuts and the potential for a fourth-quarter 2012 continuing resolution due to budget approval delays may further impact contract awards.
While the U.S. budget deficit will continue to influence government spending decisions, we expect defense funding requirements to continue to be driven by the following:
With these budget uncertainties, the long-term success of our U.S. defense business is enhanced by the relevance of our programs to the militarys funding priorities, the diversity of our programs and customers within the budget, our insight into customer requirements stemming from our incumbency on core programs, our ability to evolve our products to address a fast-changing threat environment, and our proven track record of successful contract execution.
In addition, the continuing tenuous geopolitical landscape requires governments around the world to fund weapons and equipment modernization programs, leading to diverse defense opportunities. We continue to pursue opportunities presented by international demand for military equipment and information technologies from our indigenous international operations and through exports from our U.S. businesses. While the revenue potential can be significant, international defense budgets are subject to unpredictable issues of contract award timing, changing priorities and overall spending pressures. As we broaden the customer base for our defense products around the world, we expect our international sales and exports to grow.
In our Aerospace group, business-jet market conditions showed further improvement in 2011, particularly in the large-cabin market. The group benefitted from increased flying hours across the installed base, improved new-aircraft order interest and declining customer contract defaults. Continued investment in new aircraft products is expected to drive Aerospaces long-term growth, particularly as the group remains on track to deliver its newest aircraft offerings, the G280 and the G650, in mid-2012. Similarly, we believe that
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aircraft-service revenues provide the group diversified exposure to aftermarket sales fueled by continued growth in the global installed business-jet fleet.
We are committed to creating shareholder value through innovative product development, disciplined program execution and continuous improvement initiatives. Our performance is measured in our sustained revenue growth, solid earnings and margins and efficient conversion of earnings into cash. Our record of excellent cash-flow conversion has enabled us to execute our operational strategy while providing us the flexibility to deploy our capital to further enhance shareholder returns through acquisitions, payment of dividends and share repurchases.
RESULTS OF OPERATIONS
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 the Aerospace and defense business groups. An understanding of these methods is important to the evaluation of our operating results.
In the Aerospace group, sales contracts for new aircraft have two major phases: the manufacture of the green aircraft and the aircrafts outfitting, which includes exterior painting and installation of customer-selected interiors. We record revenues on these contracts at two milestones: 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 groups other original equipment manufacturers (OEMs) completions and service businesses are recognized as work progresses or upon delivery of the service. Changes in revenues result from the number and mix of new aircraft deliveries (green and outfitted), progress on aircraft completions and the level of service activity during the period.
The majority of the groups operating costs relate to new aircraft production for firm orders and consist 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. Thus, the level of operating costs reported in a given period is based largely on the number and type of aircraft delivered. To a much lesser extent, the level of operating costs is impacted by changes in the estimated average unit cost for a production lot. Operating costs in the Aerospace groups other OEMs completions and services businesses are generally recognized as incurred.
For new aircraft, operating earnings and margins in the Aerospace group 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 groups earnings and margins include the volume and profitability of completions and services work performed, the amount and type of pre-owned aircraft sold and the level of general and administrative (G&A) costs incurred by the group, which also include selling expenses and R&D costs.
In the defense groups, revenue on long-term government contracts is recognized as work progresses, either as products are produced or as services are rendered. As a result, changes in revenues are discussed generally in terms of volume, typically measured by the level of activity on individual contracts. Year-over-year variances attributed to volume indicate increases or decreases in revenues due to changes in production or service levels and delivery schedules.
Operating costs for the defense groups consist of labor, material, subcontractor and overhead costs and are generally recognized as incurred. Variances in costs recognized from period to period primarily reflect increases and decreases in production or activity levels on individual contracts and, therefore, result largely from the same factors that drive variances in revenues.
Operating earnings and margins in the defense groups are driven by changes in volume, performance or contract mix. Performance refers to changes in profitability during the period of performance based on revisions to estimates at completion on individual contracts. These revisions result from increases or decreases to the estimated contract value or the estimated costs required to complete the contract. Therefore, changes in costs incurred in the period do not necessarily impact profitability. It is only when total estimated costs at completion change that profitability may be impacted. Contract mix refers to changes in the volume of higher- vs. lower-margin work on individual contracts and when aggregated across the contract portfolio. On an individual contract, higher or lower margins can be inherent in the contract type (e.g., fixed-price/cost-reimbursable) or type of work (e.g., development/production).
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REVIEW OF 2010 VS. 2011
Our revenues and operating costs were up slightly in 2011 compared with 2010. Revenues increased in the Aerospace group, primarily driven by initial green deliveries of the new G650 aircraft. This increase was partially offset by lower revenues in the Information Systems and Technology groups tactical communication systems business, specifically on ruggedized computing products. Operating earnings declined in 2011, resulting in a 50-basis-point decrease in margins. While operating margins were up in each of the defense businesses, operating margins decreased in the completions business for other OEMs in our Aerospace group. The decrease was caused by the impairment of an intangible asset and losses on narrow- and wide-body completions projects.
Product Revenues and Operating Costs
Product revenues were lower in 2011 compared with 2010. The decrease in product revenues consisted of the following:
In 2011, tactical communication products revenues decreased, particularly on ruggedized computing products, driven by order delays stemming from recent Congressional continuing resolutions and a protracted customer acquisition cycle. Revenues were also down on several ship construction programs, most significantly on the DDG-1000 and DDG-51 destroyer programs due to award delays and on the commercial product-carrier program, which was completed in 2010. Offsetting these decreases were higher aircraft manufacturing, outfitting and completions revenues due to initial green deliveries of the new G650 aircraft.
Product operating costs were lower in 2011 compared with 2010. The decrease in product operating costs consisted of the following:
The primary driver of the changes in product operating costs in 2011 was volume. In addition, aircraft manufacturing, outfitting and completions operating costs increased in our other OEMs completions business due to $150 of cost growth and penalties associated with delivery delays on several narrow- and wide-body completions projects and a $111 impairment of the contract and program intangible asset.
Service Revenues and Operating Costs
Service revenues increased in 2011 compared with 2010. The increase in service revenues consisted of the following:
In 2011, growth on IT support and modernization programs for the DoD and the intelligence community, coupled with the acquisition of Vangent, Inc., resulted in higher IT services revenues. The growing global installed base of business-jet aircraft and increased flying hours across the installed base resulted in higher aircraft services revenues.
Service operating costs increased in 2011 compared with 2010. The increase in service operating costs consisted of the following:
Service operating costs increased in 2011 due primarily to increased activity levels. In addition, the acquisition of Vangent, Inc., resulted in higher IT services operating costs.
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REVIEW OF 2009 VS. 2010
In 2010, our revenues and operating costs were up due to higher volume on aircraft services in our Aerospace group, U.S. Navy ship programs in our Marine Systems group and tactical communication systems and IT services in our Information Systems and Technology group, partially offset by lower U.S. military vehicle revenues in our Combat Systems group. Growth in operating earnings significantly outpaced revenue growth in 2010, resulting in a 70-basis-point increase in operating margins. While each of our business groups reported earnings growth, performance was particularly strong in the Aerospace and Combat Systems groups.
Product Revenues and Operating Costs
Product revenues decreased in 2010 compared with 2009. The decrease in product revenues consisted of the following:
In 2010, U.S. military vehicle product revenues decreased due to lower Mine-Resistant, Ambush-Protected (MRAP) vehicle production and reduced activity on vehicle development programs. The increase in tactical communication products was driven by higher volume on the Warfighter Information Network Tactical (WIN-T) program and several ruggedized computing products.
Product operating costs were lower in 2010 compared with 2009. The decrease in product operating costs consisted of the following:
The primary driver of the changes in product operating costs in 2010 was volume. In addition, pre-owned aircraft operating costs decreased due to $30 of write-downs on the carrying value of inventory in 2009.
Service Revenues and Operating Costs
Service revenues increased in 2010 compared with 2009. The increase in service revenues consisted of the following:
In 2010, IT services revenues increased due to higher volume on IT support and modernization programs for the intelligence community. Ship engineering and repair revenues increased, primarily on the U.S. Navys next-generation ballistic-missile submarine (SSBN(X)) program. Recovery in the business-jet market resulted in growth in aircraft services activity in 2010.
Service operating costs increased in 2010 compared with 2009. The increase in service operating costs consisted of the following:
The drivers of increased service operating costs in 2010 were primarily due to increased activity levels on IT, ship engineering and repair and aircraft services.
As a percentage of revenues, G&A expenses were 6.1 percent in 2009, 6 percent in 2010 and 6.2 percent in 2011. G&A expenses as a percentage of revenues increased slightly in 2011 primarily due to higher ongoing R&D efforts in our Aerospace group. We expect G&A in 2012 to be approximately 6 percent of revenues.
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Net interest expense was $160 in 2009, $157 in 2010 and $141 in 2011. The decrease in 2011 was largely due to the repayment of fixed-rate notes of $700 in the third quarter of 2010 and $750 in the third quarter of 2011, partially offset by interest expense associated with the $1.5 billion of fixed-rate notes issued in July 2011. We expect full-year 2012 net interest expense to be approximately $155 to $160, subject to capital deployment activities during the year.
In 2011, other income consisted primarily of a $38 pretax gain from the sale of the detection systems portion of the weapons systems business in our Combat Systems group, partially offset by $17 of transaction-related costs associated with our 2011 business acquisitions. For further discussion of acquisition and divestiture activity, see Note B to the Consolidated Financial Statements.
Effective Tax Rate
Our effective tax rate was 31.5 percent in 2009, 30.7 percent in 2010 and 31.4 percent in 2011. The increase in 2011 was primarily due to lower income from international operations in jurisdictions with lower tax rates. We anticipate an effective tax rate of approximately 32 percent in 2012, an increase from recent years largely due to the expiration of the R&D tax credit that Congress has not yet extended for 2012. For additional discussion of tax matters, see Note E to the Consolidated Financial Statements.
In 2010, we completed the sale of our nitrocellulose operation in Spain. The operating results of this business are presented as discontinued operations, net of income taxes, in 2009 and 2010. In 2011, we recognized a $13 loss, net of taxes, from the settlement of an environmental matter associated with a former operation of the company. We also increased our estimate of continued legal costs associated with the A-12 litigation as a result of the U.S. Supreme Courts decision that extended the expected timeline associated with the litigation, resulting in a $13 loss, net of taxes. See Note N to the Consolidated Financial Statements for further discussion of the A-12 litigation, which has been ongoing since 1991.
REVIEW OF BUSINESS GROUPS
Following is a discussion of operating results and outlook for each of our business groups. For the Aerospace group, results are analyzed with respect to specific lines of products and services, consistent with how the group is managed. For the defense groups, the discussion is based on the types of products and services each group offers with a supplemental discussion of specific contracts and programs when significant to a groups results. Additional information regarding our business groups can be found in Note Q to the Consolidated Financial Statements.
Review of 2010 vs. 2011
The Aerospace groups revenues increased in 2011 compared to 2010. The increase consisted of the following:
Aircraft manufacturing, outfitting and completions revenues include Gulfstream business-jet aircraft as well as completions of aircraft produced by other OEMs. Gulfstream aircraft manufacturing and outfitting revenues increased in 2011 due to additional large-cabin green and outfitted deliveries, primarily initial green deliveries of the first 12 G650 aircraft in the fourth quarter. Offsetting this increase were lower completions revenues as a result of manufacturing delays on narrow- and wide-body commercial aircraft contracts and continued lower volume in business-jet aircraft manufactured by other OEMs.
Aircraft services revenues, which include maintenance and repair work, fixed-base operations and aircraft management services, increased 15 percent in 2011, reflecting the growing global installed base and increased flying hours of business-jet aircraft.
Revenues from sales of pre-owned aircraft were down slightly from 2010, and the group ended 2011 with no pre-owned aircraft in inventory.
The groups operating earnings decreased in 2011. The decrease consisted of the following:
General Dynamics Annual Report 2011 23
Earnings from the manufacture and outfitting of Gulfstream aircraft increased approximately $240, or more than 20 percent, in 2011 compared with 2010 primarily due to initial green deliveries of the G650 aircraft. Earnings from other OEMs completions at Jet Aviation were down approximately $170 in 2011 primarily as a result of cost growth and penalties associated with delivery delays on several narrow- and wide-body completions projects, including $78 of contract losses in the fourth quarter. As a result of losses and lower revenues on other OEMs business-jet aircraft, we reviewed the related long-lived assets of the completions business in the fourth quarter of 2011 and recognized a $111 impairment charge on the contract and program intangible asset. We believe that major initiatives to reduce overhead and increase production efficiency undertaken by management beginning in 2011 will stabilize performance in the completions business in 2012.
Despite the increase in revenues, aircraft services earnings were steady in 2011 due to competitive market pricing and an unfavorable mix of service work. Jet Aviations aircraft services earnings were also negatively impacted by the strength of the Swiss franc as compared to the broader market.
The groups operating earnings in 2011 were negatively impacted by higher R&D expenses and selling expenses associated with increased order activity.
As a result of the factors discussed above, the groups overall operating margins decreased 400 basis points in 2011 compared with 2010. The impact on the groups operating margins from the impairment charge was 180 basis points.
Review of 2009 vs. 2010
The Aerospace groups revenues increased in 2010 primarily due to steady growth in aircraft services activity throughout the year. Aircraft manufacturing, outfitting and completions work remained consistent with 2009 levels, as an increase in manufacturing volume was offset by reduced completions. Revenues from sales of pre-owned aircraft were down slightly from 2009.
The groups operating earnings improved in 2010 compared with 2009 across the groups portfolio. Aircraft manufacturing, outfitting and completions earnings increased primarily due to higher volume. Pre-owned aircraft earnings were up due to improved pricing in the pre-owned market and the absence of write-downs of pre-owned aircraft inventory that occurred in 2009. Aircraft services earnings increased consistent with the higher volume. Operating earnings in 2010 were also favorably impacted by lower R&D expenditures. Overall, the groups operating margins increased 250 basis points compared with 2009.
We expect an increase of approximately 15 percent in the groups revenues in 2012 compared with 2011. The increase is due to additional green deliveries and initial outfitted deliveries of the G650. We expect the Aerospace groups margins to be approximately 15 percent, up from 2011 due to improved performance in our other OEMs completions business.
Review of 2010 vs. 2011
The Combat Systems groups revenues were down slightly in 2011 compared with 2010. The decrease in the groups revenues consisted of the following:
In the groups U.S. military vehicle business, volume was down due to less refurbishment and upgrade work for the Abrams main battle tank, fewer survivability enhancement kits for the Stryker wheeled combat vehicle and a decline in activity on the Expeditionary Fighting Vehicle (EFV) program as the system design and development neared completion. Increased volume on the groups contracts to provide light armored vehicles (LAVs) for several international customers partially offset these decreases.
Revenues were up slightly in the groups weapons systems and munitions businesses. Increased sales of axles in the commercial and military markets were partially offset by the timing of munitions deliveries to the Canadian government and the sale of the detection systems business in the second quarter of 2011.
Revenues in the groups European military vehicles business increased in 2011 largely due to higher volume of Duro and EAGLE wheeled vehicles to a variety of European customers, including the Swiss and German governments. Offsetting this increase was lower activity on the groups Pandur and Piranha vehicle contracts for various international customers.
The groups operating earnings and margins were up slightly in 2011, following a 130-basis-point margin improvement in 2010. The 10-basis-point increase in 2011 was primarily due to higher profitability on several major programs in our U.S. military vehicles business.
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Review of 2009 vs. 2010
In 2010, the Combat Systems groups revenues decreased compared with 2009 due to reduced volume in the groups U.S. and European military vehicles businesses. In the groups U.S. military vehicles business, lower MRAP vehicle production and reduced engineering work, primarily related to the 2009 cancellation of the manned ground vehicle portion of the Future Combat Systems (FCS) program, represented the majority of the decline in revenues. Revenues in the groups European military vehicles business decreased due to the ramp-down of the Leopard tank program for the Spanish government and lower activity on the groups Pandur and Piranha contracts.
Despite the decline in revenues, the Combat Systems groups operating earnings increased slightly in 2010, resulting in a 130-basis-point increase in operating margins compared with 2009. Productivity improvements across the group, particularly in the U.S. military vehicles business, and a favorable contract mix that included reduced engineering and development work resulted in significant margin expansion.
We expect the Combat Systems groups revenues to decrease to approximately $8.5 billion in 2012. A reduction in our U.S. military vehicles business primarily due to lower volume on the Stryker and MRAP programs will be partially offset by growth in international vehicle contracts and revenues from the December 2011 acquisition of Force Protection, Inc. We expect the groups operating margins to approximate 2011 in the low- to mid-14 percent range.
Review of 2010 vs. 2011
The Marine Systems groups revenues decreased in 2011 compared with 2010. The decrease in revenues consisted of the following:
The groups U.S. Navy ship-construction programs include Virginia-class submarines, DDG-1000 and DDG-51 destroyers, and T-AKE combat-logistics and Mobile Landing Platform (MLP) auxiliary support ships.
Revenues were down slightly in 2011 on the Virginia-class submarine program from timing of construction activity as we transitioned from the Block II to the Block III contract. In 2011, the group delivered the eighth boat while construction continued on the next six boats. Deliveries of the remaining 10 boats under contract are scheduled through 2018.
In our surface combatant business, the group received an award for construction of the second and third ships in the DDG-1000 destroyer program in the third quarter of 2011. Due to a delay in the award, revenues were down on the program in 2011. Deliveries of the three DDG-1000 ships under contract are scheduled for 2014, 2015 and 2018. On the DDG-51 program, volume was also lower as the legacy multi-ship contract neared completion with the remaining destroyer scheduled for delivery in 2012. In the third quarter of 2011, in connection with the Navys restart of the DDG-51 program, the group was awarded a construction contract for a DDG-51 destroyer scheduled for delivery in 2016 and won a competitively awarded option for an additional destroyer.
Volume increased on the MLP program in 2011 as the group commenced construction on the first ship of the three-ship program. The first ship is scheduled for delivery in 2013. In 2011, the group also received a construction contract for the second ship and long-lead funding for the third ship. Activity on the groups T-AKE program was down in 2011 as the group delivered the 11th and 12th ships in the program. The final two ships are scheduled for completion in 2012.
While Navy ship-construction revenues were down from 2010, revenues were up in 2011 on engineering and repair programs for the Navy. Volume increased in 2011 on the groups engineering work associated with the SSBN(X). The group currently is performing initial concept studies, including design of a Common Missile Compartment for the U.S. Navy and the Royal Navy of the United Kingdom, and reactor-plant planning yard services. The groups repair work increased in 2011 following significant growth in 2010, particularly on surface-ship repair programs. This growth was aided by the 2011 acquisition of Metro Machine Corp., a surface-ship repair operation located in Norfolk, Virginia. This addition, coupled with our existing capabilities, enables us to deliver maintenance and repair services to the Atlantic and Pacific fleets.
In 2010, the group completed construction of a five-ship commercial product-carrier program, resulting in a decrease in commercial shipbuilding revenues in 2011. Given the success of this program, the age of Jones Act ships and other factors, we anticipate additional commercial shipbuilding opportunities.
Despite the decrease in revenues, the Marine Systems groups operating earnings were up in 2011 compared with 2010, resulting in a 30-basis-point increase in operating margins. On the T-AKE contract, a modification negotiated during the year and favorable cost performance resulted in revisions in contract estimates that contributed 70 basis points to the
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groups 2011 operating margin expansion. This operating margin growth was offset by the absence of commercial ship construction revenues and operating margin compression as we transition to several new shipbuilding contracts and lower-margin service and design work increases.
Review of 2009 vs. 2010
Revenues in the Marine Systems group were up in 2010 primarily due to increased activity on the Virginia-class program as the group continued to ramp toward construction of two submarines per year and higher volume on the groups SSBN(X) engineering program. Lower activity on the DDG-51 and T-AKE programs and the completion of the five-ship commercial product-carrier program slightly offset other volume increases in the group in 2010.
The Marine Systems groups operating earnings increased in 2010 consistent with the increase in revenues as favorable performance on the T-AKE and commercial product-carrier programs offset a shift in program mix to new shipbuilding contracts and design work.
We expect the Marine Systems groups revenues in 2012 to decrease slightly from 2011 due to the timing of several ship-construction programs, with operating margins approximating 2011 in the low- to mid-10 percent range.
INFORMATION SYSTEMS AND TECHNOLOGY
Review of 2010 vs. 2011
The Information Systems and Technology groups revenues decreased in 2011 compared with 2010. The decrease in revenues consisted of the following:
Revenues in the tactical communication systems business were impacted unfavorably by recent continuing resolutions and a protracted customer acquisition cycle that slowed orders. This resulted in lower revenues in 2011 on ruggedized computing products, including the Common Hardware/Software III (CHS-3) program, and other products with shorter-term delivery timeframes. Additionally, revenues on the Canadian Maritime Helicopter Project (MHP) were down in 2011 as the group transitioned from production to the training and support phase of the program. Revenues were up in the groups United Kingdom-based operation due to higher volume on the initial phase of the U.K. Ministry of Defence Specialist Vehicle (SV) program.
In the IT services business, volume increased on the groups support and modernization programs for the intelligence community and the Departments of Defense (DoD) and Homeland Security, including the St. Elizabeths campus, New Campus East, Walter Reed National Military Medical Center and Mark Center infrastructure programs. Revenues also increased in this business as a result of the acquisition of Vangent, Inc., in the fourth quarter of 2011.
Revenues were down in 2011 compared with 2010 in the groups ISR business as a result of the sale of a satellite facility in 2010 and lower optical products volume.
The Information Systems and Technology groups operating earnings decreased in 2011, although at a lower rate than revenues, resulting in a 20-basis-point increase in margins compared with 2010. Higher margins in our tactical communication systems business were in part due to $95 of overhead reduction initiatives, but were largely offset by growth in our lower-margin IT services business.
Review of 2009 vs. 2010
The Information Systems and Technology group generated revenue growth in each of the groups markets in 2010, with over 5 percent organic growth. Revenues increased on the WIN-T program and ruggedized computing products in the groups tactical communication systems business. In the IT services business, higher volume on several IT support and modernization programs for the intelligence community accounted for the increase in revenues. The 2009 acquisition of Axsys Technologies, Inc., and growing levels of cyber security-related work contributed to the growth in the groups ISR business.
Operating earnings increased in 2010, although at a slightly lower rate than revenues, resulting in a modest decrease in operating margins compared with 2009. The reduction in operating margins resulted from a shift in the groups contract mix to include a growing proportion of IT services work.
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We expect 2012 revenues in the Information Systems and Technology group to be consistent with 2011 as growth in the IT services business, driven by the acquisition of Vangent, Inc., is offset by continued revenue pressure in our tactical communication systems business. The groups operating margins are expected to decline to the high-9 percent range due to the impact of continued revenue growth in our lower-margin IT services business.
Corporate operating expenses totaled $87 in 2009, $83 in 2010 and $77 in 2011. Corporate results primarily consist of compensation expense for stock options. See Note O to the Consolidated Financial Statements for additional information regarding our stock options. We expect 2012 Corporate operating expenses of approximately $80.
BACKLOG AND ESTIMATED POTENTIAL CONTRACT VALUE
Our total backlog, including funded and unfunded portions, was $57.4 billion at the end of 2011 compared with $59.6 billion at year-end 2010. Strong orders on major programs across our defense groups resulted in a book-to-bill ratio (orders divided by revenues) slightly higher than 2010, while our Aerospace group generated a book-to-bill ratio greater than one-to-one. Our backlog also increased nearly $1.8 billion due to our 2011 acquisitions.
Our backlog does not include work awarded under unfunded indefinite delivery, indefinite quantity (IDIQ) contracts or unexercised options associated with existing firm contracts, which we refer to collectively as estimated potential contract value. Customers use IDIQ contracts for several reasons, including expanding the field of available contractors to maximize competition under a given program or when they have not defined the exact timing and quantity of deliveries that will be required at the time the contract is executed. The estimated contract value includes multiple-award IDIQ contracts in which we are one of several companies competing for task orders as well as contracts where we have been designated as the sole-source supplier. We include our estimate of the remaining value we will receive under these arrangements.
Contract options in our defense businesses represent agreements to perform additional work at the election of the customer. These options are negotiated in conjunction with a firm contract and provide the terms under which the customer may procure additional units or services at a future date. Contract options in the Aerospace group represent options to purchase new aircraft and long-term agreements with fleet customers. We recognize options in backlog when the customer exercises the option and establishes a firm order.
On December 31, 2011, the estimated potential contract value associated with these IDIQ contracts and contract options was approximately $28 billion, up significantly from $21.8 billion at the end of 2010. This represents our estimate of the potential value we will receive. The actual amount of funding received in the future may be higher or lower. The estimated potential contract value increased in 2011 in our Marine Systems and Information Systems and Technology groups largely due to the DDG-51 option and Common Hardware Systems-4 (CHS-4) IDIQ contract awards. The acquisition of Vangent, Inc., in 2011 also added approximately $1.2 billion to the Information Systems and Technology groups estimated potential contract value. We expect to realize this value primarily over the next several years, reflecting continued demand for our products and services well into the future.
Aerospace funded backlog represents aircraft orders for which we have definitive purchase contracts and deposits from the customer. Funded backlog includes the groups newest aircraft models, the G650 and the G280, which are expected to receive full type certification and enter service in mid-2012. Aerospace unfunded backlog consists of agreements to provide future aircraft maintenance and support services.
The Aerospace group finished 2011 with a total backlog of $17.9 billion, up slightly from $17.8 billion at year-end 2010. In 2011, the group booked the highest number of orders for new aircraft since the introduction of the G650 in 2008. Customer defaults were down more than 15 percent from 2010.
We balance aircraft production rates with customer demand to maximize profitability and level-load production over time. This has enabled us to maintain an 18- to 24-month period between customer order and delivery of legacy large-cabin aircraft, while the G650 has accumulated approximately five years of backlog prior to initial deliveries. Although we expect order activity to remain strong and customer defaults to remain at low levels, backlog will likely decrease over the next several years as we deliver on our G650 backlog and the time period between customer order and delivery of the aircraft normalizes.
Over the past few years, the groups customer base has become increasingly diverse in customer type and geographic region. Approximately two-thirds of the groups year-end backlog is composed of private companies and individual buyers. While the installed base of aircraft is predominately in North America, international customers represent nearly 65 percent of the groups backlog. Approximately 70 percent of the groups orders in 2011 were from international customers, with significant growth in orders from the Asia-Pacific region. In 2011, Gulfstream received an $810 order from Minsheng
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Financial Leasing, the Chinese financial leasing company of Minsheng Bank, for the purchase of 20 Gulfstream aircraft across the product portfolio over several years.
In 2011, a fleet customer informed us of its intent not to purchase 40 large-cabin aircraft. We removed these aircraft from the groups estimated potential contract value with no impact to annual scheduled deliveries. At year end, there were no options to purchase new aircraft or long-term agreements with fleet customers included in estimated potential contract value.
The total backlog for our defense groups represents the estimated remaining sales value of work to be performed under firm contracts. The funded portion of the defense backlog includes items that have been authorized and appropriated by the Congress and funded by the customer, as well as commitments by international customers that are similarly approved and funded by their governments. While there is no guarantee that future budgets and appropriations will provide funding for a given program, we have included in backlog only firm contracts we believe are likely to receive funding.
Total backlog in our defense groups decreased 5 percent in 2011 to $39.5 billion at the end of the year, compared with $41.7 billion at the end of 2010. Over 70 percent of the decline during 2011 was in our Marine Systems group, which continued work on large, multi-year construction contracts awarded in prior periods.
Combat Systems total backlog was $11.4 billion at the end of 2011, down slightly from $11.8 billion at year-end 2010. The groups backlog primarily consists of long-term production contracts.
The Armys Stryker wheeled combat vehicle program represented $1.5 billion of the groups backlog at year end with vehicles scheduled for delivery through 2014. The group received over $1.4 billion of Stryker orders in 2011, including awards for production of 292 double-V-hulled vehicles and 100 Nuclear, Biological and Chemical Reconnaissance Vehicles, and contractor logistics support and engineering services.
The groups backlog at year end included $1.1 billion for M1 Abrams main battle tank modernization and upgrade programs. In 2011, the group received awards totaling $380 for all Abrams-related programs. The group continued work on a multi-year contract awarded in 2008 to upgrade M1A1 Abrams tanks to the M1A2 System Enhancement Package (SEP) configuration. The groups Abrams backlog at year end included $330 for the SEP program. Abrams backlog also includes $200 for Tank Urban Survivability Kits (TUSK), which increase the tanks utility and crew survivability in urban warfare environments, and $310 for production of M1A1 Abrams tank kits for the Egyptian Land Forces under the Egyptian tank co-production program.
The groups backlog at year end also included $400 for the Technology Development phase of the Armys Ground Combat Vehicle (GCV) program and $280 under the MRAP program, largely for upgrade kits for previously-delivered vehicles. The acquisition of Force Protection, Inc., in 2011 added $660 to the groups backlog, including $200 for the Buffalo mine clearance vehicle and $185 for the smaller Ocelot light patrol vehicle.
The Combat Systems group has several significant international military vehicle production contracts in backlog. The backlog at the end of the year included:
The Combat Systems groups backlog at year end also included $2.7 billion in weapons systems and munitions programs. In 2011, the group received awards totaling $630 for axles in the military and commercial markets and $305 for the production of Hydra-70 rockets. The group also received awards worth $335 from the Canadian government to supply various calibers of ammunition and $190 from the Marine Corps for ammunition for the Expeditionary Fire Support System.
Combat Systems backlog does not include $3.5 billion of estimated potential contract value associated with the groups anticipated share of IDIQ contracts and unexercised options. The groups estimated potential contract value decreased approximately 25 percent since year-end 2010
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largely due to funding under IDIQ contracts and options that were then transferred to backlog, including the Hydra-70 rocket program.
The Marine Systems groups backlog consists of long-term submarine and ship construction programs, as well as numerous engineering and repair contracts. The group generally receives large contract awards that provide backlog for several years. For example, in 2008, the group received a $14 billion contract for the construction of eight Virginia-class submarines to be delivered through 2018, increasing backlog to an all-time high of $26.4 billion at the end of 2008. Consistent with this historical pattern, as the group has performed on these multi-year contracts, the backlog has decreased to $18.5 billion at year-end 2011 compared to $20.1 billion at the end of 2010. While backlog decreased in our submarine business, backlog increased in both of our surface shipyards from major contract awards in 2011.
The Virginia-class submarine program was the companys largest program in 2011 and is the largest contract in the groups backlog. The groups backlog at year end included $11 billion for ten Virginia-class submarines. As the prime contractor on the Virginia-class program, we report the entire backlog and revenues associated with the program but share the construction activity and the earnings with our teaming partner. Plans published by the Navy include a request for proposals in 2012 for nine submarines under a fourth block of the program.
Navy destroyer programs represent another significant component of the groups backlog. These include the Arleigh Burke-class DDG-51 and Zumwalt-class DDG-1000 destroyer programs. In 2011, the group received approximately $1.6 billion in orders under the DDG-1000 program, bringing the value in backlog to $1.8 billion for the construction of three ships, including two awarded in 2011, and continued engineering and support services. At year end, the backlog also included $620 for DDG-51 destroyers. The final destroyer under the Navys legacy multi-ship contract is scheduled for delivery in 2012. Additionally, in connection with the Navys restart of the DDG-51 program, the group was awarded in 2011 a construction contract for a DDG-51 destroyer and won a competitively awarded option for an additional destroyer.
The Marine Systems groups backlog at year end included $660 for the MLP program. In 2011, the group was awarded construction contracts for the first two ships in the program and long-lead funding for the third ship. The year-end backlog also included approximately $315 for the last two ships under the Navys T-AKE combat-logistics ship program and $160 for the groups second ship under the Navys Littoral Combat Ship (LCS) program, scheduled for delivery in 2012.
In addition, the Marine Systems groups backlog at year end included approximately $3.9 billion for engineering, repair, overhaul and other services. This includes $2.3 billion in design and engineering efforts for the SSBN(X). The group received several significant contract awards in 2011 totaling $645 to continue development work. Additionally, the acquisition of Metro Machine Corp. in 2011 added $485 to the groups backlog for maintenance and repair services to be performed in Norfolk, Virginia. The group also received a $35 award in 2011 for the outfitting of the San Antonio-class amphibious assault dock ship (LPD) USS San Diego, with an option for work on two additional ships.
INFORMATION SYSTEMS AND TECHNOLOGY
The Information Systems and Technology groups total backlog was $9.6 billion at the end of 2011, down slightly from $9.8 billion at year-end 2010. Backlog was impacted in part by award delays stemming from recent continuing resolutions. The groups backlog does not include approximately $22.4 billion of estimated potential contract value associated with its anticipated share of IDIQ contracts and unexercised options. In 2011, funding under IDIQ contracts and options contributed over $3.9 billion to the groups backlog, or over 35 percent of the groups orders. The estimated potential contract value in the Information Systems and Technology group increased nearly 50 percent from year-end 2010, most notably due to the $3.7 billion CHS-4 contract award and the acquisition of Vangent, Inc., that added $1.2 billion. When combined, the groups backlog and estimated potential contract value increased by 28 percent over 2010 to $32 billion.
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Unlike our other defense businesses, the Information Systems and Technology groups backlog consists of thousands of contracts and has to be reconstituted each year with new program and task order awards. Nonetheless, there are several significant contracts that provide a solid foundation for the business.
Programs for the U.K. Ministry of Defence comprised $670 of the groups backlog at the end of 2011. Work continued in 2011 on the demonstration phase of the Ministry of Defence Specialist Vehicle program. In this phase, the group will manage the design, integration and production of seven prototype vehicles. Work and the backlog under the contract are shared with the Combat Systems group, including a significant portion of the future vehicle production effort. The group has successfully fielded the Bowman communications system, the secure digital voice and data communications system for the U.K. armed forces, and is now performing maintenance and long-term support and enhancement activities for the program.
The groups backlog at year-end 2011 included approximately $330 for the Armys WIN-T program. Information Systems and Technology is the prime contractor on this battlefield communications network. In 2011, the group received approximately $370 of awards for WIN-T. The backlog does not include $795 of estimated potential contract value for the WIN-T program awarded under an IDIQ contract.
The Information Systems and Technology groups backlog at year end also included $150 for the CHS-3 program to provide commercial and ruggedized computers, network equipment and software to the U.S. armed forces and other U.S. federal agencies. In 2011, the group received $250 in orders under this program, bringing the total contract value to more than $2.6 billion. The group also received an IDIQ contract award for the next phase of the program, CHS-4.
The groups backlog at the end of 2011 included approximately $755 for a number of support and modernization programs for the intelligence community and the Departments of Defense and Homeland Security, including the St. Elizabeths campus, New Campus East, NETCENTS and Walter Reed National Military Medical Center infrastructure programs.
In addition to these programs, the group received a number of significant contract awards in 2011, including the following:
Information Systems and Technology was awarded several significant IDIQ contracts during 2011, including the following:
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
We place a strong emphasis on cash flow generation. This focus has afforded us the financial flexibility to deploy our cash resources to generate shareholder value while preserving a strong balance sheet to position us for future opportunities. In 2011, cash flows from operations exceeded net earnings for the 13th consecutive year. The $9.1 billion of cash generated by operating activities over the past three years was deployed to fund acquisitions and capital expenditures, repurchase our common stock, pay dividends and repay maturing debt. Our net debt, defined as debt less cash and equivalents and marketable securities, was $1 billion at year-end 2011, up by $655 from $378 at the end of 2010 largely due to the issuance of fixed-rate notes in 2011 and continued capital deployment activities.
Our cash balances are invested primarily in time deposits from highly rated banks, commercial paper rated A1/P1 or higher and short-term repurchase agreements with direct obligations of the Spanish government as collateral. Our marketable securities balances are invested primarily in term deposits and high-quality corporate, municipal and U.S. government-sponsored debt securities. The marketable securities have an average duration of one year and an average credit rating of AA-. We have not incurred any material losses associated with these investments. On December 31, 2011, $635 of our cash was held by international operations and is therefore not immediately available to fund domestic operations unless the cash is repatriated. While we do not intend to do so, should this amount be repatriated, it would be subject to U.S. federal income tax but would generate partially offsetting foreign tax credits.
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We expect to continue to generate funds in excess of our short- and long-term liquidity needs. We believe we have adequate funds on hand and sufficient borrowing capacity to execute our financial and operating strategy. The following is a discussion of our major operating, investing and financing activities for each of the past three years, as classified on the Consolidated Statement of Cash Flows.
We generated cash from operating activities of $2.9 billion in 2009, $3 billion in 2010 and $3.2 billion in 2011. In all three years, the operating cash flow was attributed primarily to net earnings. In 2011, operating cash flow also benefitted from customer deposits due upon receipt of provisional type certification of the G650. Cash from operating activities reflects contributions to our pension plans, which have grown in recent years from $300 in 2009 to $350 in 2011, with contributions of $500 expected in 2012.
Termination of A-12 Program. As discussed further in Note N to the Consolidated Financial Statements, litigation on the A-12 program termination has been ongoing since 1991. If, contrary to our expectations, the default termination ultimately is sustained and the government prevails on its recovery theories, we, along with The Boeing Company, could collectively be required to repay the U.S. government as much as $1.4 billion for progress payments received for the A-12 contract, plus interest, which was approximately $1.6 billion on December 31, 2011. If this were the outcome, we would owe half of the total, or approximately $1.5 billion pretax. Our after-tax cash obligation would be approximately $735. We believe we have sufficient resources, including access to capital markets, to pay such an obligation, if required.
We used $1.4 billion in 2009, $408 in 2010 and $2 billion in 2011 for investing activities. The primary uses of cash in investing activities were business acquisitions, capital expenditures and purchases of marketable securities. Investing activities also include proceeds received from the sale of assets and marketable securities.
Business Acquisitions. In 2009, we completed two acquisitions for $811. In 2010, we completed three acquisitions for $233. In 2011, we completed six acquisitions for $1.6 billion. We used cash on hand to fund these acquisitions. See Note B to the Consolidated Financial Statements for further discussion of acquisition activity.
Capital Expenditures. Capital expenditures were $385 in 2009, $370 in 2010 and $458 in 2011. The increase in 2011 compared with 2009 and 2010 is due largely to Gulfstreams $500, seven-year Savannah, Georgia, facilities expansion project announced in 2010. We expect capital expenditures of approximately $600 in 2012, or 2 percent of anticipated revenues, as work on Gulfstreams facilities project increases.
Marketable Securities. As a result of lower market interest rates, we expanded our investment strategy several years ago to take advantage of the additional return generated by available-for-sale and held-to-maturity securities. Net purchases of these securities were $235 in 2009 compared with net proceeds of $115 in 2010 and net purchases of $49 in 2011.
Other, Net. Investing activities also included proceeds from the sale of a satellite facility in our Information Systems and Technology group in 2010 and the detection systems portion of the weapons systems business in the Combat Systems group in 2011.
We used $806 in 2009, $2.2 billion in 2010 and $1.2 billion in 2011 for financing activities. Our financing activities include issuances and repayments of debt, payment of dividends and repurchases of common stock. Net cash from financing activities also includes proceeds received from stock option exercises.
Debt Proceeds, Net. In 2009, we issued $750 of two-year fixed-rate notes. In 2011, we issued $1.5 billion of fixed-rate notes in $500 increments due in January 2015, July 2016 and July 2021. We used the proceeds from these fixed-rate notes in part to repay the $750 of fixed-rate notes issued in 2009. In August 2010, we repaid $700 of fixed-rate notes. We have no material repayments of long-term debt expected until 2013. See Note J to the Consolidated Financial Statements for additional information regarding our debt obligations, including scheduled debt maturities.
We ended 2011 with no commercial paper outstanding. We have $2 billion in bank credit facilities that remain available. These facilities provide backup liquidity to our commercial paper program. We also have an effective shelf registration on file with the Securities and Exchange Commission.
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Dividends. Our board of directors declared a quarterly dividend of $0.47 per share on March 2, 2011, the 14th consecutive annual increase. The board had previously approved a quarterly dividend of $0.42 per share in March 2010 and $0.38 per share in March 2009.
Share Repurchases. Our board of directors has historically supported managements tactical repurchase of our shares, typically in repurchase authorizations of 10-million-share increments. We repurchased 3.6 million shares on the open market in 2009, 18.9 million shares in 2010 and 20 million shares in 2011. As a result, we reduced our shares outstanding by 4.2 percent in 2011 and nearly 8 percent since 2009. On October 5, 2011, with no shares remaining under a prior authorization, the board authorized management to repurchase up to 10 million shares, about 3 percent of our total shares outstanding.
NON-GAAP MANAGEMENT METRICS
We emphasize the efficient conversion of net earnings into cash and the deployment of that cash to maximize shareholder returns. As described below, we use free cash flow and return on invested capital (ROIC) to measure our ability to efficiently convert net earnings into cash and earn a return on the deployment of that capital.
Free Cash Flow. We define free cash flow from operations as net cash provided by operating activities less capital expenditures. We believe free cash flow from operations is a useful measure for investors, because it portrays our ability to generate cash from our operations for purposes such as repaying maturing debt, funding business acquisitions, repurchasing our common stock and paying dividends. We use free cash flow from operations to assess the quality of our earnings and as a performance measure in evaluating management. Over the past five years, we have generated free cash flow from operations in excess of our earnings from continuing operations during the period at an average 107 percent conversion rate. The following table reconciles the free cash flow from operations with net cash provided by operating activities, as classified on the Consolidated Statement of Cash Flows:
Return on Invested Capital. We believe ROIC is a useful measure for investors because it reflects our ability to generate returns from the capital we have deployed in our operations. We use ROIC to evaluate investment decisions and as a performance measure in evaluating management. We define ROIC as net operating profit after taxes divided by the sum of the average debt and shareholders equity for the year. Net operating profit after taxes is defined as earnings from continuing operations plus after-tax interest and amortization expense. Over the past five years, our ROIC has averaged 17.4 percent. ROIC is calculated as follows:
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ADDITIONAL FINANCIAL INFORMATION
OFF-BALANCE SHEET ARRANGEMENTS
On December 31, 2011, other than operating leases, we had no material off-balance sheet arrangements, including guarantees; retained or contingent interests in assets transferred to unconsolidated entities; derivative instruments indexed to our stock and classified in shareholders equity on the Consolidated Balance Sheet; or variable interests in entities that provide us with financing, liquidity, market-risk or credit-risk support or engage with us in leasing, hedging or research and development services.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS
The following tables present information about our contractual obligations and commercial commitments on December 31, 2011:
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Managements Discussion and Analysis of Financial Condition and Results of Operations is based on our Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of financial statements in accordance with GAAP requires that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the period. On an ongoing basis, we evaluate our estimates, including most pervasively those related to various assumptions and projections for our long-term contracts and programs. Other significant estimates include those related to goodwill and other intangible assets, income taxes, pensions and other post-retirement benefits, workers compensation, warranty obligations, pre-owned aircraft inventory, and commitments and contingencies. We make our best estimates on historical and current experience and various other assumptions that we believe to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results could differ from these estimates. We believe that our judgment is applied consistently and produces financial information that fairly depicts the results of operations for all periods presented.
We believe the following policies are critical and require the use of significant business judgment in their application:
Revenue Recognition. We account for revenues and earnings using the percentage-of-completion method. Under this method, contract revenue and profit are recognized as work progresses, either as products are produced or as services are rendered. We determine progress using either input measures
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(e.g., costs incurred) or output measures (e.g., contract milestones or units delivered), as appropriate to the circumstances. An input measure is used unless an output measure is identified that is reliably determinable and representative of progress toward completion. We estimate the profit on a contract as the difference between the total estimated revenue and the total estimated costs of a contract and recognize that profit over the life of the contract. If at any time the estimate of contract profitability reveals an anticipated loss on the contract, we recognize the loss in the quarter it is identified.
We generally measure progress toward completion on contracts in our defense businesses based on the proportion of costs incurred to date relative to total estimated costs at completion (input measure). For our contracts for the manufacture of business-jet aircraft we record revenue at two contractual milestones: when green aircraft are delivered to, and accepted by, the customer and when the customer accepts final delivery of the fully outfitted aircraft (output measure). We do not recognize revenue at green delivery unless (1) a contract has been executed with the customer and (2) the customer can be expected to satisfy its obligations under the contract, as evidenced by the receipt of significant deposits from the customer and other factors.
Accounting for long-term contracts and programs involves the use of various techniques to estimate total contract revenues and costs. Contract estimates are based on various assumptions that utilize the professional knowledge and experience of our engineers, program and operations managers and finance and accounting personnel to project the outcome of future events. These events often span several years, including labor productivity and availability; the complexity of the work to be performed; the cost and availability of materials; the performance of subcontractors; and the availability and timing of funding from the customer. We include in our contract estimates claims against the customer for changes in specifications or other disputes when the amount can be estimated reliably and its realization is probable. In evaluating these criteria, we consider the contractual/legal basis for the claim, the cause of any additional costs incurred, the reasonableness of those costs and the objective evidence available to support the claim. We include award or incentive fees in the estimated contract value when there is a basis to reasonably estimate the amount of the fee. Estimates of award or incentive fees are based on historical award experience and anticipated performance. These estimates are based on our best judgment at the time. As a significant change in one or more of these estimates could affect the profitability of our contracts, we review our performance monthly and update our contract estimates at least annually and often quarterly as well as when required by specific events or circumstances.
We recognize changes in estimated profit on contracts under the reallocation method. Under the reallocation method, the impact of revisions in estimates is recognized prospectively over the remaining contract term. We use this method because we believe the majority of factors that typically result in changes in estimates on our long-term contracts affect the period in which the change is identified and future periods. These changes generally reflect our current expectations as to future performance and, therefore, the reallocation method is the method that best matches our profits to the periods in which they are earned. Alternatively, most government contractors recognize the impact of a change in estimated profit immediately under the cumulative catch-up method. As a result, the impact on operating earnings in the period the change is identified is generally lower under the reallocation method as compared to the cumulative catch-up method. The net increase in our operating earnings from the quarterly impact of revisions in contract estimates totaled $350 in 2010 and $410 in 2011, reflecting favorable operational performance across our contract portfolio. Other than revisions discussed in the Aerospace and Marine Systems business groups results of operations, no revisions on any one contract were material.
Goodwill and Intangible Assets. Since 1995, we have acquired over 60 businesses at a total cost of approximately $22 billion, including six in 2011. In connection with these acquisitions, we have recognized $13.6 billion and $1.8 billion of goodwill and intangible assets, respectively.
Goodwill represents the purchase price paid in excess of the fair value of net tangible and intangible assets acquired. Goodwill is not amortized but is subject to an impairment test on an annual basis and when circumstances indicate that an impairment is more likely than not, such as a significant adverse change in the business climate for one of our reporting units or a decision to dispose of a reporting unit or a significant portion of a reporting unit. The test for goodwill impairment is a two-step process that requires a significant level of estimation by management, particularly the estimate of the fair value of our reporting units. These estimates require the use of judgment. We estimate the fair value of our reporting units based on the discounted projected cash flows of the underlying operations. This requires numerous assumptions, including the timing of work embedded in our backlog, our performance and profitability under our contracts, our success in securing future business and the appropriate interest rate used to discount the projected cash flows. This discounted cash flow analysis is corroborated by top-down analyses, including a market assessment of our enterprise value. We have recorded no goodwill impairment to date nor do we anticipate any reasonably possible circumstances that would lead to impairment in the foreseeable future. The fair value of each of our reporting units on December 31, 2011, exceeded its carrying value under the first step of the two-step goodwill impairment test.
We review intangible assets subject to amortization for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Impairment losses, where identified, are determined as the excess of the carrying value over the estimated fair value of the long-lived asset. We assess the recoverability of the carrying value of assets held for use based on a review of projected undiscounted cash flows. We recorded an impairment loss in 2011 related to our completions business as discussed in the Aerospace groups results of operations.
Commitments and Contingencies. We are subject to litigation and other legal proceedings arising either from the ordinary course of our business or under provisions relating to the protection of the environment. Estimating liabilities and costs associated with these matters requires the use of judgment. We record a charge against earnings when a liability associated with claims or pending or threatened litigation matters is
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probable and when our exposure is reasonably estimable. The ultimate resolution of our exposure related to these matters may change as further facts and circumstances become known.
Deferred Contract Costs. Certain costs incurred in the performance of our government contracts are recorded under GAAP but are not allocable currently to contracts. Such costs include 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 have elected to defer (or inventory) these costs in contracts in process until they can be allocated to contracts. We expect to recover these costs through ongoing business, including existing backlog and probable follow-on contracts. Our business base includes numerous contracts for which we are the sole source or one of two suppliers on long-term defense programs. We regularly assess the probability of recovery of these costs under our current and probable follow-on contracts. This assessment requires that we make assumptions about future contract costs, the extent of cost recovery under our contracts and the amount of future contract activity. These estimates are based on our best judgment. 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.
Retirement Plans. Our defined-benefit pension and other post-retirement benefit costs and obligations depend on a series of assumptions and estimates. The key assumptions relate to the interest rates used to discount estimated future liabilities and projected long-term rates of return on plan assets. We determine the discount rate used each year based on the rate of return currently available on a portfolio of high-quality fixed-income investments with a maturity that is consistent with the projected benefit payout period. We determine the long-term rate of return on assets based on consideration of historical and forward-looking returns and the current and expected asset allocation strategy. These estimates are based on our best judgment, including consideration of current and future market conditions. In the event a change in any of the assumptions is warranted, pension and post-retirement benefit cost could increase or decrease. For the impact of hypothetical changes in the discount rate and expected long-term rate of return on plan assets for our commercial pension and post-retirement benefit plans, see Note P to the Consolidated Financial Statements.
As discussed under Deferred Contract Costs, our contractual arrangements with the U.S. government provide for the recovery of benefit costs for our government retirement plans. We have elected to defer recognition of the benefit costs that cannot currently be allocated to contracts to provide a better matching of revenues and expenses. Accordingly, the impact on the retirement benefit cost for these plans that results from annual changes in assumptions does not impact our earnings either positively or negatively.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We are exposed to market risk, primarily from foreign currency exchange rates, interest rates, commodity prices and investments. See Note M to the Consolidated Financial Statements contained in Part II, Item 8, of this Annual Report on Form 10-K for a discussion of these risks. The following discussion quantifies the market risk exposure arising from hypothetical changes in foreign currency exchange rates and interest rates.
Foreign Currency Risk. We had notional forward foreign exchange contracts outstanding of $4.2 billion on December 31, 2010, and $4 billion on December 31, 2011. A 10 percent unfavorable exchange rate movement in our portfolio of foreign currency forward contracts would have resulted in the following incremental pretax gains and losses:
This exchange-rate sensitivity relates primarily to changes in the U.S. dollar/Canadian dollar, euro/Canadian dollar and U.S. dollar/euro exchange rates. We believe these hypothetical recognized and unrecognized gains and losses would be offset by corresponding losses and gains in the remeasurement of the underlying transactions being hedged. We believe these forward contracts and the offsetting underlying commitments, when taken together, do not create material market risk.
Interest Rate Risk. Our financial instruments subject to interest rate risk include fixed-rate long-term debt obligations and variable-rate commercial paper. On December 31, 2011, we had $3.9 billion par value of fixed-rate debt and no commercial paper outstanding. Our fixed-rate debt obligations are not putable, and we do not trade these securities in the market. A 10 percent unfavorable interest rate movement would not have a material impact on the fair value of our debt obligations.
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 December 31, 2011, we held $2.9 billion in cash and equivalents and marketable securities, which had an aggregate weighted average maturity of less than two months on December 31, 2011. Our marketable securities have an average duration of one year and an average credit rating of AA-. A 10 percent unfavorable interest rate movement would not have a material impact on the value of the holdings. Historically, we have not experienced material gains or losses on these instruments due to changes in interest rates or market values.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENT OF EARNINGS
The accompanying Notes to Consolidated Financial Statements are an integral part of this statement.
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CONSOLIDATED BALANCE SHEET
The accompanying Notes to Consolidated Financial Statements are an integral part of this statement.
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CONSOLIDATED STATEMENT OF CASH FLOWS