Annual Reports

 
Quarterly Reports

  • 10-Q (Oct 22, 2014)
  • 10-Q (Jul 23, 2014)
  • 10-Q (Apr 23, 2014)
  • 10-Q (Oct 23, 2013)
  • 10-Q (Jul 24, 2013)
  • 10-Q (Apr 30, 2013)

 
8-K

 
Other

General Dynamics 10-Q 2008
Form 10-Q for the quarterly period ended June 29, 2008
Table of Contents

 

LOGO

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

 

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

For the quarterly period ended June 29, 2008

OR

 

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

Commission File Number 1-3671

 

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

 

Delaware     13-1673581

State or other jurisdiction of

incorporation or organization

   

I.R.S. Employer

Identification No.

 

2941 Fairview Park Drive Suite 100

Falls Church, Virginia

    22042-4513
Address of principal executive offices     Zip code

 

  (703) 876-3000  
 

Registrant’s telephone number,

including area code

 

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

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

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

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

397,260,758 shares of the registrant’s common stock, $1 par value per share, were outstanding at July 27, 2008.

 

 


Table of Contents

INDEX

 

     PAGE

PART I - FINANCIAL INFORMATION

  

Item 1 -

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

Item 2 -

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    25

Item 3 -

   Quantitative and Qualitative Disclosures About Market Risk    38

Item 4 -

   Controls and Procedures    38

FORWARD-LOOKING STATEMENTS

   39

PART II - OTHER INFORMATION

  

Item 1 -

   Legal Proceedings    40

Item 1A -

   Risk Factors    40

Item 2 -

   Unregistered Sales of Equity Securities and Use of Proceeds    40

Item 4 -

   Submission of Matters to a Vote of Security Holders    41

Item 6 -

   Exhibits    43

SIGNATURES

   44

 

-2-


Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

CONSOLIDATED BALANCE SHEET

 

(Dollars in millions)    (Unaudited)
June 29
2008
    December 31
2007
 

ASSETS

                

Current assets:

    

Cash and equivalents

   $ 2,740     $ 2,891  

Accounts receivable

     2,962       2,874  

Contracts in process

     4,505       4,337  

Inventories

     1,672       1,621  

Other current assets

     569       575  

Total current assets

     12,448       12,298  

Noncurrent assets:

    

Property, plant and equipment, net

     2,546       2,472  

Intangible assets, net

     920       972  

Goodwill

     8,986       8,942  

Other assets

     1,189       1,049  

Total noncurrent assets

     13,641       13,435  

Total assets

   $ 26,089     $ 25,733  

LIABILITIES AND SHAREHOLDERS’ EQUITY

                

Current liabilities:

    

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

   $ 172     $ 673  

Accounts payable

     2,115       2,318  

Customer advances and deposits

     3,776       3,440  

Other current liabilities

     2,643       2,733  

Total current liabilities

     8,706       9,164  

Noncurrent liabilities:

    

Long-term debt

     2,117       2,118  

Other liabilities

     3,082       2,683  

Commitments and contingencies (See Note J)

                

Total noncurrent liabilities

     5,199       4,801  

Shareholders’ equity:

    

Common stock

     482       482  

Surplus

     1,255       1,141  

Retained earnings

     12,313       11,379  

Treasury stock

     (2,545 )     (1,881 )

Accumulated other comprehensive income

     679       647  

Total shareholders’ equity

     12,184       11,768  

Total liabilities and shareholders’ equity

   $ 26,089     $ 25,733  

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

 

-3-


Table of Contents

CONSOLIDATED STATEMENT OF EARNINGS

(UNAUDITED)

 

     Three Months Ended  
(Dollars in millions, except per share amounts)    June 29
2008
    July 1
2007
 

Net sales:

    

Products

   $ 5,104     $ 4,500  

Services

     2,199       2,091  
       7,303       6,591  

Operating costs and expenses:

    

Products

     4,404       3,959  

Services

     1,978       1,872  
       6,382       5,831  

Operating earnings

     921       760  

Interest, net

     (12 )     (21 )

Other, net

     —         1  

Earnings from continuing operations before income taxes

     909       740  

Provision for income taxes, net

     268       222  

Earnings from continuing operations

     641       518  

Discontinued operations, net of tax

     —         (5 )

Net earnings

   $ 641     $ 513  

Earnings per share

    

Basic:

    

Continuing operations

   $ 1.61     $ 1.28  

Discontinued operations

     —         (0.01 )

Net earnings

   $ 1.61     $ 1.27  

Diluted:

    

Continuing operations

   $ 1.60     $ 1.27  

Discontinued operations

     —         (0.01 )

Net earnings

   $ 1.60     $ 1.26  

Supplemental information:

    

General and administrative expenses included in operating costs and expenses

   $ 451     $ 417  

Dividends per share

   $ 0.35     $ 0.29  

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

 

-4-


Table of Contents

CONSOLIDATED STATEMENT OF EARNINGS

(UNAUDITED)

 

     Six Months Ended  
(Dollars in millions, except per share amounts)    June 29
2008
    July 1
2007
 

Net sales:

    

Products

   $ 9,964     $ 8,841  

Services

     4,344       4,050  
       14,308       12,891  

Operating costs and expenses:

    

Products

     8,614       7,805  

Services

     3,912       3,645  
       12,526       11,450  

Operating earnings

     1,782       1,441  

Interest, net

     (31 )     (47 )

Other, net

     3       2  

Earnings from continuing operations before income taxes

     1,754       1,396  

Provision for income taxes, net

     540       438  

Earnings from continuing operations

     1,214       958  

Discontinued operations, net of tax

     (1 )     (11 )

Net earnings

   $ 1,213     $ 947  

Earnings per share

    

Basic:

    

Continuing operations

   $ 3.04     $ 2.36  

Discontinued operations

     —         (0.03 )

Net earnings

   $ 3.04     $ 2.33  

Diluted:

    

Continuing operations

   $ 3.01     $ 2.34  

Discontinued operations

     —         (0.03 )

Net earnings

   $ 3.01     $ 2.31  

Supplemental information:

    

General and administrative expenses included in operating costs and expenses

   $ 881     $ 810  

Dividends per share

   $ 0.70     $ 0.58  

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

 

-5-


Table of Contents

CONSOLIDATED STATEMENT OF CASH FLOWS

(UNAUDITED)

 

     Six Months Ended  
(Dollars in millions)    June 29
2008
    July 1
2007
 

Cash flows from operating activities:

    

Net earnings

   $ 1,213     $ 947  

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

    

Depreciation of property, plant and equipment

     146       132  

Amortization of intangible assets

     67       75  

Stock-based compensation expense

     50       41  

Excess tax benefit from stock-based compensation

     (24 )     (26 )

Deferred income tax provision

     26       53  

Discontinued operations, net of tax

     1       11  

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

    

Accounts receivable

     (83 )     (186 )

Contracts in process

     (163 )     (188 )

Inventories

     (73 )     (100 )

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

    

Accounts payable

     (207 )     (159 )

Customer advances and deposits

     548       417  

Other current liabilities

     (27 )     (54 )

Other, net

     (18 )     (36 )

Net cash provided by operating activities from continuing operations

     1,456       927  

Net cash used by discontinued operations - operating activities

     (5 )     (8 )

Net cash provided by operating activities

     1,451       919  

Cash flows from investing activities:

    

Purchases of available-for-sale securities

     (1,247 )     (48 )

Sales/maturities of available-for-sale securities

     1,186       42  

Capital expenditures

     (200 )     (166 )

Business acquisitions, net of cash acquired

     (66 )     (299 )

Proceeds from sale of assets, net

     30       93  

Other, net

     1       (1 )

Net cash used by investing activities

     (296 )     (379 )

Cash flows from financing activities:

    

Purchases of common stock

     (660 )     (153 )

Repayment of fixed-rate notes

     (500 )     —    

Dividends paid

     (257 )     (210 )

Proceeds from option exercises

     89       102  

Excess tax benefit from stock-based compensation

     24       26  

Other, net

     (2 )     (115 )

Net cash used by financing activities

     (1,306 )     (350 )

Net (decrease)/increase in cash and equivalents

     (151 )     190  

Cash and equivalents at beginning of period

     2,891       1,604  

Cash and equivalents at end of period

   $ 2,740     $ 1,794  

Supplemental cash flow information:

    

Cash payments for:

    

Income taxes

   $ 516     $ 365  

Interest

   $ 66     $ 64  

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

 

-6-


Table of Contents

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

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

 

A. Basis of Preparation

The Company

The term “company” or “General Dynamics” used in this document refers to General Dynamics Corporation and all of its wholly owned and majority-owned subsidiaries.

Interim Financial Statements

The unaudited Consolidated Financial Statements included in this Form 10-Q have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. These rules and regulations permit some of the information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) to be condensed or omitted.

Operating results for the three- and six-month periods ended June 29, 2008, are not necessarily indicative of the results that may be expected for the year ending December 31, 2008.

In management’s opinion, the unaudited Consolidated Financial Statements contain all adjustments, that are of a normal recurring nature, necessary for a fair presentation of the company’s results for the three- and six-month periods ended June 29, 2008, and July 1, 2007.

These unaudited Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in the company’s Annual Report on Form 10-K for the year ended December 31, 2007.

Classification

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

 

-7-


Table of Contents
B. Acquisitions, Intangible Assets and Goodwill

General Dynamics acquired Integrated Defense Systems, Inc. (IDSI), of Glen Rock, Pennsylvania, on February 29, 2008, for approximately $65 in cash. IDSI produces advanced filtering technologies and broadband power amplifiers for tactical communications applications for military and other government customers. IDSI is included in the Information Systems and Technology group.

In 2007, General Dynamics acquired four businesses for an aggregate of approximately $330 in cash.

Aerospace

 

   

WECO Aerospace Systems, Inc. (WECO), of Lincoln, California, on March 2. WECO is an aviation-component overhaul company specializing in electronic accessories and flight instrument services.

Combat Systems

 

   

SNC Technologies Inc. (SNC TEC), a wholly owned subsidiary of SNC-Lavalin Group Inc. of Montreal, Quebec, on January 5. SNC TEC is an ammunition system integrator that supplies small-, medium- and large-caliber ammunition and related products to the Canadian Forces, U.S. and other national defense customers, and law enforcement agencies around the world.

Information Systems and Technology

 

   

Monteria, LLC (Monteria), of Mount Airy, Maryland, on October 24. Monteria designs and manufactures technology and systems dedicated exclusively to supporting the signals intelligence (SIGINT) community.

 

   

Mediaware International Pty Ltd. (Mediaware) of Australia on November 13. Mediaware develops real-time full-motion compressed digital video processing software and systems for defense, intelligence and commercial customers.

General Dynamics funded each of the above acquisitions using cash on hand. The operating results of these businesses have been included with the company’s results since the respective closing dates of the acquisitions. The purchase prices of these businesses have been allocated to the estimated fair value of net tangible and intangible assets acquired, with any excess purchase price recorded as goodwill. Some of the estimates related to the IDSI acquisition were still preliminary at June 29, 2008. The company is in the process of identifying and valuing intangible and other assets acquired. The completion of these analyses could result in an increase or decrease to the preliminary value assigned to these acquired assets, as well as to future periods’ amortization expense. The company expects the analyses to be completed by the third quarter of 2008 without any material adjustments.

 

-8-


Table of Contents

Intangible assets consisted of the following:

 

     June 29
2008
   December 31
2007
      Gross
Carrying
Amount
   Accumulated
Amortization
    Net
Carrying
Amount
   Gross
Carrying
Amount
   Accumulated
Amortization
    Net
Carrying
Amount

Contract and program intangible assets

   $ 1,372    $ (557 )   $ 815    $ 1,366    $ (504 )   $ 862

Other intangible assets

     324      (219 )     105      316      (206 )     110

Total intangible assets

   $ 1,696    $ (776 )   $ 920    $ 1,682    $ (710 )   $ 972

Contract and program intangible assets represent primarily acquired backlog and probable follow-on work and related customer relationships. The company amortizes these assets over 6 to 40 years. The weighted-average amortization life of these assets as of June 29, 2008, was 17 years. Other intangible assets consist primarily of aircraft product design and customer lists, amortized over 9 and 21 years, respectively, and software and licenses, amortized over 6 to 24 years. The company amortizes intangible assets on a straight-line basis unless the pattern of usage indicates an alternative method is more representative of the usage of the asset.

Amortization expense was $34 and $67 for the three- and six-month periods ended June 29, 2008, and $36 and $75 for the three- and six-month periods ended July 1, 2007. The company expects to record annual amortization expense over the next five years as follows:

 

2009

   $ 130

2010

   $ 126

2011

   $ 119

2012

   $ 115

2013

   $ 85

 

-9-


Table of Contents

The changes in the carrying amount of goodwill by business group for the six months ended June 29, 2008, were as follows:

 

      Aerospace    Combat
Systems
   Marine
Systems
    Information
Systems and
Technology
    Total
Goodwill

December 31, 2007

   $ 355    $ 2,308    $ 185     $ 6,094     $ 8,942

Acquisitions (a)

     1      —        (2 )     42       41

Other (b)

     —        5      —         (2 )     3

June 29, 2008

   $ 356    $ 2,313    $ 183     $ 6,134     $ 8,986

 

  (a) Includes adjustments to preliminary assignment of fair value to net assets acquired.
  (b) Consists of adjustments for foreign currency translation.

 

C. Earnings per Share and Comprehensive Income

Earnings per Share

General Dynamics computes basic earnings per share using net earnings for the respective period and the weighted average number of common shares outstanding during the period. Diluted earnings per share incorporates the incremental shares issuable upon the assumed exercise of stock options and the issuance of restricted shares.

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

 

     Three Months Ended    Six Months Ended
      June 29
2008
   July 1
2007
   June 29
2008
   July 1
2007

Basic weighted average shares outstanding

   398,491    405,150    399,625    405,373

Dilutive effect of stock options and restricted stock

   3,280    3,750    3,189    3,795

Diluted weighted average shares outstanding

   401,771    408,900    402,814    409,168

Comprehensive Income

The company’s comprehensive income was $628 and $1,245 for the three- and six-month periods ended June 29, 2008, respectively, and $590 and $1,033 for the three- and six-month periods ended July 1, 2007, respectively. The primary components of the company’s comprehensive income are net earnings and foreign currency translation adjustment.

 

-10-


Table of Contents
D. Fair Value of Financial Instruments

On January 1, 2008, the company adopted Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements, with respect to its financial assets and liabilities. SFAS 157 defines “fair value” in the context of accounting and financial reporting and establishes a framework for measuring fair value under GAAP. SFAS 157 is effective for the company’s non-financial assets and liabilities on January 1, 2009. The company did not have any significant assets or liabilities measured at fair value as of June 29, 2008, that have not been accounted for under SFAS 157. The following is a summary of the assets and liabilities recorded at fair value on the Consolidated Balance Sheet as of June 29, 2008:

 

      Fair Value  

Marketable securities

   $ 226  

Derivative financial instruments

     (63 )

The fair value of each of the assets and liabilities above was determined using quoted market prices in active markets for identical instruments.

 

E. Contracts in Process

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

 

      June 29
2008
   December 31
2007

Contract costs and estimated profits

   $ 12,034    $ 11,224

Other contract costs

     1,169      1,200
     13,203      12,424

Less advances and progress payments

     8,698      8,087

Total contracts in process

   $ 4,505    $ 4,337

Contract costs consist primarily of labor and material costs and related overhead and general and administrative (G&A) expenses. Contract costs also include contract recoveries for matters such as contract changes, negotiated settlements and claims for unanticipated contract costs, which totaled approximately $60 as of June 29, 2008, and $20 as of December 31, 2007. The company records revenue associated with these matters only when recovery can be estimated reliably and realization is probable. Contract costs as of June 29, 2008, also included approximately $245 associated with the company’s contract to provide Pandur II wheeled vehicles to the Czech Republic. In the second quarter of 2008, the company entered into a memorandum of understanding and a testing agreement with the Czech Republic regarding the testing and acceptance of 17 Pandur II vehicles completed by the company under a contract for 199 vehicles. These agreements are part of ongoing negotiations between the company and the Czech Republic following a notice of termination delivered by the customer in December 2007. The parties are negotiating a revised contract for the purchase of 107 vehicles, including the 17 completed vehicles, and the company expects to recover the June 29, 2008, contracts-in-process balance over the course of the revised contract.

 

-11-


Table of Contents

Other contract costs represent amounts recorded under GAAP that are not currently allocable to government contracts, such as a portion of the company’s estimated workers’ compensation, other insurance-related assessments, pension and other post-retirement benefits, and environmental expenses. These costs will become allocable to contracts generally when they are paid. The company expects to recover these costs through ongoing business, including existing backlog and probable follow-on contracts. This business base includes numerous contracts for which the company is the sole source or is one of two suppliers on long-term U.S. defense programs. However, if the backlog in the future does not support the continued deferral of these costs, the profitability of the company’s remaining contracts could be adversely affected. The company expects to bill substantially all of its June 29, 2008, contracts-in-process balance, with the exception of these other contract costs, during the next 12 months.

 

F. Inventories

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

 

      June 29
2008
   December 31
2007

Work in process

   $ 828    $ 774

Raw materials

     812      804

Pre-owned aircraft

     —        30

Other

     32      13

Total inventories

   $ 1,672    $ 1,621

 

G. Debt

Debt consisted of the following:

 

      Interest
Rate
   June 29
2008
   December 31
2007

Fixed-rate notes due:

        

May 2008

   3.000%    $ —      $ 500

August 2010

   4.500%      699      699

May 2013

   4.250%      999      999

August 2015

   5.375%      400      400

Senior notes due September 2008

   6.320%      150      150

Term debt due December 2008

   7.500%      20      20

Other

   Various      21      23

Total debt

        2,289      2,791

Less current portion

          172      673

Long-term debt

        $ 2,117    $ 2,118

 

-12-


Table of Contents

As of June 29, 2008, General Dynamics had outstanding $2.1 billion aggregate principal amount of fixed-rate notes. The sale of the fixed-rate notes was registered under the Securities Act of 1933, as amended. The notes are fully and unconditionally guaranteed by several of the company’s 100-percent-owned subsidiaries. The company has the option to redeem the notes prior to their maturity in whole or in part at 100 percent of the principal plus any accrued but unpaid interest and any applicable make-whole amounts. See Note M for condensed consolidating financial statements.

The senior notes are privately placed U.S. dollar-denominated notes issued by one of the company’s Canadian subsidiaries. Interest is payable semiannually at an annual rate of 6.32 percent until maturity in September 2008. The subsidiary has a currency swap that fixes both the interest payments and principal at maturity of these notes. As of June 29, 2008, the fair value of this currency swap was a $67 liability, which offset the effect of changes in the currency exchange rate on the related debt. The senior notes are backed by a parent company guarantee.

The company assumed the term debt in connection with the acquisition of Primex Technologies, Inc., in 2001. The company made a final annual sinking fund payment of $5 in December 2007. A final semiannual interest payment is due at maturity in December at a rate of 7.5 percent annually.

As of June 29, 2008, and December 31, 2007, the company had no commercial paper outstanding but maintains the ability to access the market. The company has approximately $2 billion in bank credit facilities that provide backup liquidity to its commercial paper program. These credit facilities consist of a $1 billion multiyear facility expiring in July 2009 and a $975 multiyear facility expiring in December 2011. The company’s commercial paper issuances and the bank credit facilities are guaranteed by several of the company’s 100-percent-owned subsidiaries. Additionally, a number of the company’s international subsidiaries have available local bank credit facilities aggregating approximately $960.

The company’s financing arrangements contain a number of customary covenants and restrictions. The company was in compliance with all material covenants as of June 29, 2008.

 

-13-


Table of Contents
H. Liabilities

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

 

      June 29
2008
   December 31
2007

Retirement benefits

   $ 592    $ 585

Salaries and wages

     588      571

Workers’ compensation

     522      534

Other (a)

     941      1,043

Total other current liabilities

   $ 2,643    $ 2,733

Customer deposits on commercial contracts (b)

   $ 1,053    $ 707

Deferred U.S. federal income taxes

     967      970

Retirement benefits

     559      499

Other (c)

     503      507

Total other liabilities

   $ 3,082    $ 2,683

 

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

 

  (b) The increase in customer deposits resulted from significant order activity in the Aerospace group, including orders for the new ultra-large-cabin, ultra-long-range G650 aircraft.

 

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

 

I. Income Taxes

The company’s net deferred tax liability was included in the Consolidated Balance Sheet as follows:

 

      June 29
2008
    December 31
2007
 

Current deferred tax asset

   $ 84     $ 94  

Current deferred tax liability

     (27 )     (22 )

Noncurrent deferred tax asset

     20       11  

Noncurrent deferred tax liability

     (993 )     (997 )

Net deferred tax liability

   $ (916 )   $ (914 )

On November 27, 2001, General Dynamics filed a refund suit in the U.S. Court of Federal Claims, titled General Dynamics v. United States, for the years 1991 to 1993. The company added the years 1994 to 1998 to the litigation on June 23, 2004. The suit seeks recovery of refund claims that were disallowed by the Internal Revenue Service (IRS) at the administrative level. On December 30, 2005, the court issued its opinion regarding one of the issues in the case. The court held that the company could not treat the A-12 contract as complete for federal income tax purposes in 1991, the year the contract was terminated. (See Note J for more information regarding the A-12 contract.) In the second quarter of 2008, the company reached a settlement with the government, which has been approved by the Joint Committee on Taxation of the Congress.

 

-14-


Table of Contents

As a result of the settlement, the company expects to receive a refund of $35, including after-tax interest. Accordingly, the company reduced its tax provision in the second quarter of 2008 by $35 (or $0.09 per share).

The IRS has examined all of the company’s consolidated federal income tax returns through 2004. The IRS commenced its examination of the company’s 2005 and 2006 income tax returns in October 2007, and the company expects this examination to conclude in 2009. The company has recorded liabilities for tax contingencies for all years that remain open to review. The company does not expect the resolution of tax matters for these years to have a material impact on its results of operations, financial condition or cash flows.

With respect to income tax uncertainties, the company believes that the total amount of unrecognized tax benefits as of June 29, 2008, is not material to its results of operations, financial condition or cash flows. The company also believes that the total amount of unrecognized tax benefits as of June 29, 2008, if recognized, would not have a material impact on its effective tax rate. The company further believes, based on all known facts and circumstances and current tax law, that there are no tax positions for which it is reasonably possible that the unrecognized tax benefits will significantly increase or decrease over the next 12 months producing, individually or in the aggregate, a material effect on the company’s results of operations, financial condition or cash flows.

 

J. Commitments and Contingencies

Litigation

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

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

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

 

-15-


Table of Contents

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

On May 3, 2007, the trial court issued a decision upholding the government’s default termination. The company believes that the trial court failed to follow the appeals court ruling and continues to believe that the evidence supports a determination that the government’s default termination was not justified. The case is currently on appeal with the appeals court.

If, contrary to the company’s expectations, the default termination is ultimately sustained, the contractors could collectively be required to repay the government as much as $1.4 billion for progress payments received for the A-12 contract, plus interest, which was approximately $1.4 billion at June 29, 2008. This would result in a liability for the company of approximately $1.4 billion pretax. The company’s after-tax charge would be approximately $765, or $1.90 per share, to be recorded in discontinued operations. The company’s after-tax cash cost would be approximately $680. The company believes it has sufficient resources to satisfy its obligation if required.

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

Environmental

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

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

 

-16-


Table of Contents

Other

In the ordinary course of business, General Dynamics has entered into letters of credit and other similar arrangements with financial institutions and insurance carriers totaling approximately $1.4 billion at June 29, 2008. The company, from time to time in the ordinary course of business, guarantees the payment or performance obligations of its subsidiaries arising under certain contracts. The company is aware of no event of default that would require it to satisfy these guarantees.

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

The company provides product warranties to its customers associated with the majority of its product sales. The company records estimated warranty costs in the period in which the related products are delivered. The warranty liability recorded at each balance sheet date is based on the estimated number of months of warranty coverage remaining for products delivered and the average historical monthly warranty payments, and is included in other current liabilities and other liabilities on the Consolidated Balance Sheet.

The changes in the carrying amount of warranty liabilities for the six-month periods ended June 29, 2008, and July 1, 2007, were as follows:

 

     Six Months Ended  
      June 29
2008
    July 1
2007
 

Beginning balance

   $ 237     $ 219  

Warranty expense

     35       32  

Payments

     (22 )     (25 )

Reclassification

     (38 )     —    

Ending balance*

   $ 212     $ 226  

 

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

 

-17-


Table of Contents
K. Retirement Plans

The company provides defined-benefit pension and other post-retirement benefits, as well as defined-contribution benefits, to eligible employees.

Net periodic pension and other post-retirement benefit costs for the three- and six-month periods ended June 29, 2008, and July 1, 2007, consisted of the following:

 

     Pension Benefits    

Other

Post-retirement Benefits

 
Three Months Ended    June 29
2008
    July 1
2007
    June 29 2008     July 1
2007
 

Service cost

   $ 51     $ 53     $ 4     $ 4  

Interest cost

     111       104       17       16  

Expected return on plan assets

     (149 )     (139 )     (7 )     (6 )

Recognized net actuarial loss

     1       3       —         1  

Amortization of prior service cost

     (12 )     (11 )     —         —    

Net periodic cost

   $ 2     $ 10     $ 14     $ 15  
     Pension Benefits    

Other

Post-retirement Benefits

 
Six Months Ended    June 29
2008
    July 1
2007
   

June 29

2008

    July 1
2007
 

Service cost

   $ 102     $ 106     $ 8     $ 8  

Interest cost

     222       208       33       32  

Expected return on plan assets

     (298 )     (277 )     (14 )     (13 )

Recognized net actuarial loss

     2       6       —         3  

Amortization of prior service cost

     (24 )     (23 )     1       1  

Amortization of transition obligation

     —         —         1       1  

Net periodic cost

   $ 4     $ 20     $ 29     $ 32  

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

 

-18-


Table of Contents
L. Business Group Information

General Dynamics operates in four business groups: Aerospace, Combat Systems, Marine Systems and Information Systems and Technology. The company organizes and measures its business groups in accordance with the nature of products and services offered. These business groups derive their revenues from business aviation; combat vehicles, weapons systems and munitions; shipbuilding design and construction; and information systems, technologies and services, respectively. The company measures each group’s profit based on operating earnings. As a result, the company does not allocate net interest, other income and expense items, and income taxes to its business groups.

Summary operating results for each of the company’s business groups follows:

 

     Net Sales    Operating Earnings  
Three Months Ended    June 29
2008
   July 1
2007
   June 29
2008
    July 1
2007
 

Aerospace

   $ 1,329    $ 1,208    $ 240     $ 199  

Combat Systems

     2,015      1,712      282       191  

Marine Systems

     1,394      1,272      127       112  

Information Systems and Technology

     2,565      2,399      292       269  

Corporate*

     —        —        (20 )     (11 )
     $ 7,303    $ 6,591    $ 921     $ 760  
     Net Sales    Operating Earnings  
Six Months Ended    June 29
2008
   July 1
2007
   June 29
2008
    July 1
2007
 

Aerospace

   $ 2,608    $ 2,302    $ 476     $ 372  

Combat Systems

     4,012      3,280      541       365  

Marine Systems

     2,772      2,529      249       210  

Information Systems and Technology

     4,916      4,780      552       519  

Corporate*

     —        —        (36 )     (25 )
     $ 14,308    $ 12,891    $ 1,782     $ 1,441  

 

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

 

-19-


Table of Contents
M. Condensed Consolidating Financial Statements

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

Condensed Consolidating Statement of Earnings

 

Three Months Ended June 29, 2008    Parent     Guarantors
on a
Combined
Basis
    Other
Subsidiaries
on a
Combined
Basis
    Consolidating
Adjustments
    Total
Consolidated
 

Net sales

   $ —       $ 6,428     $ 875     $ —       $ 7,303  

Cost of sales

     —         5,218       713       —         5,931  

General and administrative expenses

     20       373       58       —         451  

Operating earnings

     (20 )     837       104       —         921  

Interest expense

     (28 )     —         (5 )     —         (33 )

Interest income

     11       1       9       —         21  

Other, net

     (1 )     —         1       —         —    

Earnings before income taxes

     (38 )     838       109       —         909  

Provision for income taxes

     (46 )     289       25       —         268  

Equity in net earnings of subsidiaries

     633       —         —         (633 )     —    

Net earnings

   $ 641     $ 549     $ 84     $ (633 )   $ 641  
Three Months Ended July 1, 2007                                    

Net sales

   $ —       $ 5,727     $ 864     $ —       $ 6,591  

Cost of sales

     (6 )     4,710       710       —         5,414  

General and administrative expenses

     17       349       51       —         417  

Operating earnings

     (11 )     668       103       —         760  

Interest expense

     (29 )     (1 )     (4 )     —         (34 )

Interest income

     4       —         9       —         13  

Other, net

     —         1       —         —         1  

Earnings from continuing operations before income taxes

     (36 )     668       108       —         740  

Provision for income taxes

     (35 )     225       32       —         222  

Discontinued operations, net of tax

     —         (5 )     —         —         (5 )

Equity in net earnings of subsidiaries

     514       —         —         (514 )     —    

Net earnings

   $ 513     $ 438     $ 76     $ (514 )   $ 513  

 

-20-


Table of Contents

Condensed Consolidating Statement of Earnings

 

Six Months Ended June 29, 2008    Parent     Guarantors
on a
Combined
Basis
    Other
Subsidiaries
on a
Combined
Basis
    Consolidating
Adjustments
    Total
Consolidated
 

Net sales

   $ —       $ 12,426     $ 1,882     $ —       $ 14,308  

Cost of sales

     —         10,099       1,546       —         11,645  

General and administrative expenses

     36       721       124       —         881  

Operating earnings

     (36 )     1,606       212       —         1,782  

Interest expense

     (61 )     —         (10 )     —         (71 )

Interest income

     23       2       15       —         40  

Other, net

     1       1       1       —         3  

Earnings from continuing operations before income taxes

     (73 )     1,609       218       —         1,754  

Provision for income taxes

     (64 )     552       52       —         540  

Discontinued operations, net of tax

     —         (1 )     —         —         (1 )

Equity in net earnings of subsidiaries

     1,222       —         —         (1,222 )     —    

Net earnings

   $ 1,213     $ 1,056     $ 166     $ (1,222 )   $ 1,213  
Six Months Ended July 1, 2007                                    

Net sales

   $ —       $ 11,230     $ 1,661     $ —       $ 12,891  

Cost of sales

     (5 )     9,262       1,383       —         10,640  

General and administrative expenses

     30       680       100       —         810  

Operating earnings

     (25 )     1,288       178       —         1,441  

Interest expense

     (57 )     (2 )     (7 )     —         (66 )

Interest income

     7       —         12       —         19  

Other, net

     —         1       1       —         2  

Earnings from continuing operations before income taxes

     (75 )     1,287       184       —         1,396  

Provision for income taxes

     (60 )     438       60       —         438  

Discontinued operations, net of tax

     —         (11 )     —         —         (11 )

Equity in net earnings of subsidiaries

     962       —         —         (962 )     —    

Net earnings

   $ 947     $ 838     $ 124     $ (962 )   $ 947  

 

-21-


Table of Contents

Condensed Consolidating Balance Sheet

 

June 29, 2008    Parent     Guarantors
on a
Combined
Basis
    Other
Subsidiaries
on a
Combined
Basis
    Consolidating
Adjustments
    Total
Consolidated
 

ASSETS

          

Current assets:

          

Cash and equivalents

   $ 1,898     $ —       $ 842     $ —       $ 2,740  

Accounts receivable

     —         1,635       1,327       —         2,962  

Contracts in process

     413       2,938       1,154       —         4,505  

Inventories

          

Work in process

     —         811       17       —         828  

Raw materials

     —         782       30       —         812  

Other

     —         24       8       —         32  

Other current assets

     264       75       230       —         569  

Total current assets

     2,575       6,265       3,608       —         12,448  

Noncurrent assets:

          

Property, plant and equipment

     129       3,989       812       —         4,930  

Accumulated depreciation of PP&E

     (27 )     (1,976 )     (381 )     —         (2,384 )

Intangible assets and goodwill

     —         8,849       1,833       —         10,682  

Accumulated amortization of intangible assets

     —         (635 )     (141 )     —         (776 )

Other assets

     627       419       143       —         1,189  

Investment in subsidiaries

     21,145       —         —         (21,145 )     —    

Total noncurrent assets

     21,874       10,646       2,266       (21,145 )     13,641  

Total assets

   $ 24,449     $ 16,911     $ 5,874     $ (21,145 )   $ 26,089  

LIABILITIES AND SHAREHOLDERS’ EQUITY

          

Current liabilities:

          

Short-term debt

   $ —       $ 22     $ 150     $ —       $ 172  

Liabilities of discontinued operations

     —         41       —         —         41  

Other current liabilities

     545       5,224       2,724       —         8,493  

Total current liabilities

     545       5,287       2,874       —         8,706  

Noncurrent liabilities:

          

Long-term debt

     2,098       11       8       —         2,117  

Other liabilities

     402       2,326       354       —         3,082  

Total noncurrent liabilities

     2,500       2,337       362       —         5,199  

Intercompany

     9,220       (8,996 )     (454 )     230       —    

Shareholders’ equity:

          

Common stock, including surplus

     1,737       6,131       1,526       (7,657 )     1,737  

Retained earnings

     12,313       12,243       1,083       (13,326 )     12,313  

Other shareholders’ equity

     (1,866 )     (91 )     483       (392 )     (1,866 )

Total shareholders’ equity

     12,184       18,283       3,092       (21,375 )     12,184  

Total liabilities and shareholders’ equity

   $ 24,449     $ 16,911     $ 5,874     $ (21,145 )   $ 26,089  

 

-22-


Table of Contents

Condensed Consolidating Balance Sheet

 

December 31, 2007    Parent     Guarantors
on a
Combined
Basis
    Other
Subsidiaries
on a
Combined
Basis
    Consolidating
Adjustments
    Total
Consolidated
 

ASSETS

          

Current assets:

          

Cash and equivalents

   $ 1,875     $ —       $ 1,016     $ —       $ 2,891  

Accounts receivable

     —         1,648       1,226       —         2,874  

Contracts in process

     418       2,872       1,047       —         4,337  

Inventories

          

Work in process

     —         766       8       —         774  

Raw materials

     —         777       27       —         804  

Pre-owned aircraft

     —         30       —         —         30  

Other

     —         16       (3 )     —         13  

Assets of discontinued operations

     —         3       —         —         3  

Other current assets

     281       80       211       —         572  

Total current assets

     2,574       6,192       3,532       —         12,298  

Noncurrent assets:

          

Property, plant and equipment

     128       3,834       767       —         4,729  

Accumulated depreciation of PP&E

     (24 )     (1,882 )     (351 )     —         (2,257 )

Intangible assets and goodwill

     —         8,793       1,831       —         10,624  

Accumulated amortization of intangible assets

     —         (585 )     (125 )     —         (710 )

Other assets

     548       420       81       —         1,049  

Investment in subsidiaries

     19,884       —         —         (19,884 )     —    

Total noncurrent assets

     20,536       10,580       2,203       (19,884 )     13,435  

Total assets

   $ 23,110     $ 16,772     $ 5,735     $ (19,884 )   $ 25,733  

LIABILITIES AND SHAREHOLDERS’ EQUITY

          

Current liabilities:

          

Short-term debt

   $ 500     $ 22     $ 151     $ —       $ 673  

Liabilities of discontinued operations

     —         46       —         —         46  

Other current liabilities

     500       5,149       2,796       —         8,445  

Total current liabilities

     1,000       5,217       2,947       —         9,164  

Noncurrent liabilities:

          

Long-term debt

     2,098       12       8       —         2,118  

Other liabilities

     407       1,963       313       —         2,683  

Total noncurrent liabilities

     2,505       1,975       321       —         4,801  

Intercompany

     7,837       (7,631 )     (461 )     255       —    

Shareholders’ equity:

          

Common stock, including surplus

     1,623       6,100       1,546       (7,646 )     1,623  

Retained earnings

     11,379       11,195       950       (12,145 )     11,379  

Other shareholders’ equity

     (1,234 )     (84 )     432       (348 )     (1,234 )

Total shareholders’ equity

     11,768       17,211       2,928       (20,139 )     11,768  

Total liabilities and shareholders’ equity

   $ 23,110     $ 16,772     $ 5,735     $ (19,884 )   $ 25,733  

 

-23-


Table of Contents

Condensed Consolidating Statement of Cash Flows

 

Six Months Ended June 29, 2008    Parent     Guarantors
on a
Combined
Basis
    Other
Subsidiaries
on a
Combined
Basis
    Consolidating
Adjustments
   Total
Consolidated
 

Net cash provided by operating activities

   $ (46 )   $ 1,513     $ (16 )   $ —      $ 1,451  

Cash flows from investing activities:

           

Purchases of available-for-sale securities

     (1,187 )     (27 )     (33 )     —        (1,247 )

Sales/maturities of available-for-sale securities

     1,163       23       —         —        1,186  

Other, net

     (1 )     (207 )     (27 )     —        (235 )

Net cash used by investing activities

     (25 )     (211 )     (60 )     —        (296 )

Cash flows from financing activities:

           

Purchases of common stock

     (660 )     —         —         —        (660 )

Repayment of fixed-rate notes

     (500 )     —         —         —        (500 )

Dividends paid

     (257 )     —         —         —        (257 )

Other, net

     113       (1 )     (1 )     —        111  

Net cash used by financing activities

     (1,304 )     (1 )     (1 )     —        (1,306 )

Cash sweep/funding by parent

     1,398       (1,301 )     (97 )     —        —    

Net decrease in cash and equivalents

     23       —         (174 )     —        (151 )

Cash and equivalents at beginning of period

     1,875       —         1,016       —        2,891  

Cash and equivalents at end of period

   $ 1,898     $ —       $ 842     $ —      $ 2,740  
Six Months Ended July 1, 2007                                   

Net cash provided by operating activities

   $ (191 )   $ 1,036     $ 74     $ —      $ 919  

Cash flows from investing activities:

           

Business acquisitions, net of cash acquired

     —         (18 )     (281 )     —        (299 )

Other, net

     37       (95 )     (22 )     —        (80 )

Net cash used by investing activities

     37       (113 )     (303 )     —        (379 )

Cash flows from financing activities:

           

Dividends paid

     (210 )     —         —         —        (210 )

Purchases of common stock

     (153 )     —         —         —        (153 )

Other, net

     128       (1 )     (114 )     —        13  

Net cash used by financing activities

     (235 )     (1 )     (114 )     —        (350 )

Cash sweep/funding by parent

     630       (922 )     292       —        —    

Net increase in cash and equivalents

     241       —         (51 )     —        190  

Cash and equivalents at beginning of period

     594       —         1,010       —        1,604  

Cash and equivalents at end of period

   $ 835     $ —       $ 959     $ —      $ 1,794  

 

-24-


Table of Contents

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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

Business Overview

General Dynamics offers a broad portfolio of products and services in business aviation; combat vehicles, weapons systems and munitions; shipbuilding design and construction; and information systems, technologies and services. The company operates through four business groups – Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology. General Dynamics’ primary customers are the U.S. military, other U.S. government organizations, the armed forces of other nations, and a diverse base of corporate, government and individual buyers of business aircraft. The company operates in two primary markets: defense and business aviation. The majority of the company’s revenues derive from contracts with the U.S. military. The following discussion should be read in conjunction with the company’s 2007 Annual Report on Form 10-K, filed with the Securities and Exchange Commission, and with the unaudited Consolidated Financial Statements included herein.

Results of Operations

Consolidated Overview

 

Three Months Ended    June 29
2008
    July 1
2007
    Variance  

Net sales

   $ 7,303     $ 6,591     $ 712    10.8 %

Operating earnings

     921       760       161    21.2 %

Operating margin

     12.6 %     11.5 %             
Six Months Ended    June 29
2008
    July 1
2007
    Variance  

Net sales

   $ 14,308     $ 12,891     $ 1,417    11.0 %

Operating earnings

     1,782       1,441       341    23.7 %

Operating margin

     12.5 %     11.2 %             

General Dynamics produced strong net sales growth in the second quarter and first six months of 2008, and operating earnings increased at double the rate of sales growth in both periods. Increased production activity and improved operating performance across the company led to increased sales, operating earnings and margins in each of the company’s four business groups in the second quarter and first half of 2008 over the same periods in 2007. The Aerospace and Combat Systems groups have produced the most significant sales and earnings growth to-date in 2008. The company’s overall operating margins improved 110 basis points in the second quarter and 130 basis points in the first half of 2008.

 

-25-


Table of Contents

General and administrative (G&A) expenses as a percentage of net sales for the first half of 2008 were 6.2 percent compared with 6.3 percent in the same period in 2007. The company expects G&A expenses as a percentage of sales for the full-year 2008 to approximate the full-year 2007 rate of 6.0 percent.

Net cash provided by operating activities from continuing operations was $1.5 billion, compared with $927 in the first six months of 2007. The company used cash to repurchase its common stock, pay dividends, repay maturing debt, and fund acquisitions and capital expenditures. The company’s net debt – debt less cash and equivalents and short-term investments – was a net cash surplus of $571 at the end of the second quarter of 2008 compared with net debt of $995 at second quarter 2007. The company achieved this $1.6 billion improvement after deploying approximately $100 on acquisitions, more than $1 billion of share repurchases and approximately $490 of dividends paid during the past 12 months. The company expects to generate cash from operating activities well in excess of net earnings for the full-year 2008.

The company’s net interest expense in the first half of 2008 decreased by $16, or 34 percent, from the first six months of 2007 due to additional interest income on a higher average invested cash balance. The company expects full-year net interest expense of approximately $55 to $60.

The company’s effective tax rate for the six-month period ended June 29, 2008, was 30.8 percent compared with 31.4 percent in the same period in 2007. In the second quarter of 2008, the Joint Committee on Taxation of the Congress approved a proposed settlement between the company and the U.S. Department of Justice related to a tax refund suit. This resulted in a $35 – or approximately $0.09 per-share – benefit in the second quarter, which reduced the tax rate for the first half of 2008 by 200 basis points. In the first half of 2007, the effective tax rate was impacted favorably by the resolution of the company’s 2003-2004 federal income tax audit. This settlement resulted in an $18, or $0.05 per-share benefit, which reduced the effective tax rate in the first half of 2007 by 130 basis points. The company anticipates an effective tax rate of approximately 31.5 percent for the full-year 2008 including the effect of the second-quarter settlement. For additional discussion of tax matters, see Note I to the unaudited Consolidated Financial Statements.

The company completed the sale of its coal mining operation in the third quarter of 2007. The company’s reported net earnings include as discontinued operations the operating results of this business prior to the sale in 2007 and final adjustments to the loss on the sale in 2008.

The company generated total new orders of $12.3 billion in the second quarter of 2008, resulting in significant growth in the company’s backlog. The company’s total backlog was $55.3 at the end of the second quarter of 2008, up 11 percent over the first quarter of 2008. Funded backlog grew 13 percent to $45.2 billion as of June 29, 2008. The increase in total and funded backlog was due to strong order activity across the company, with particularly significant orders in the Aerospace group following the introduction of the new Gulfstream G650 business jet in the quarter. Total and funded backlog in the company’s defense businesses decreased slightly in the second quarter of 2008 due to the timing of a number of key awards, which were delayed past the end of the quarter. The company’s total backlog does not include work awarded under unfunded indefinite delivery, indefinite quantity (IDIQ) contracts, unexercised options associated with existing firm contracts or options to purchase new aircraft. Management’s estimate of this potential contract value, which may be realized by the company over the next 14 years, was approximately $17.4 billion at the end of the second quarter 2008, up 19 percent from $14.6 billion at the end of the first quarter.

 

-26-


Table of Contents

Aerospace

 

Three Months Ended    June 29
2008
    July 1
2007
    Variance  

Net sales

   $ 1,329     $ 1,208     $ 121    10.0 %

Operating earnings

     240       199       41    20.6 %

Operating margin

     18.1 %     16.5 %             

Aircraft deliveries (in units):

         

Green

     39       36       3    8.3 %

Completion

     40       36       4    11.1 %
Six Months Ended    June 29
2008
    July 1
2007
    Variance  

Net sales

   $ 2,608     $ 2,302     $ 306    13.3 %

Operating earnings

     476       372       104    28.0 %

Operating margin

     18.3 %     16.2 %             

Aircraft deliveries (in units):

         

Green

     76       66       10    15.2 %

Completion

     76       66       10    15.2 %

The Aerospace group generated substantial net sales growth in the second quarter and first six months of 2008 compared with the same prior-year periods. The group continued to increase its aircraft production schedule to fill its growing order backlog and delivered more green and completed aircraft in 2008 compared with 2007. As a result, new aircraft sales grew 12 percent in the second quarter and 15 percent in the first half of 2008. Higher aircraft services volume also contributed to the sales growth, increasing 8 percent in the second quarter and 16 percent in the first half of 2008. Pre-owned aircraft sales were $8 in the second quarter and $17 in the first six months of 2008 compared with $22 and $43 in the second quarter and first half of 2007, respectively.

The group’s operating earnings increased at more than double the rate of sales growth in the second quarter and first six months of 2008. Operating earnings grew approximately $33 in the second quarter of 2008 as a result of higher new-aircraft and aircraft-services volume. In the first half of 2008, increased new-aircraft and aircraft-services volume contributed $81 of the earnings growth. Improved pricing and a favorable mix of aircraft delivered in 2008 compared with 2007, as well as continued labor efficiencies and productivity improvements, further contributed to the group’s increased earnings in 2008. These factors generated approximately $33 and $56 of earnings growth in the second quarter and first six months of 2008, respectively. Increased selling costs related to strong order activity and higher product-development expenses due to the timing of the group’s spending resulted in significantly higher G&A costs in 2008 compared to 2007. The increases in these costs reduced the group’s earnings growth by approximately $26 in the second quarter and $33 in the first six months of 2008.

The group’s operating margins increased 160 basis points in the second quarter and 210 basis points in the first half of the year over the same periods in 2007. The increased margins resulted primarily from improved pricing on the units delivered in 2008 compared with 2007, as well as a favorable mix of deliveries, particularly within the large-cabin aircraft. The group’s selling and product-development costs as a percentage of sales were higher in 2008. This offset the growth in the group’s margins by approximately 130 basis points in the quarter and 30 basis points year-to-date.

 

-27-


Table of Contents

The company expects sales growth in the Aerospace group of between 13 and 14 percent for the full-year 2008 based on the planned new-aircraft delivery schedule. The company expects the group’s full-year margins to be in the mid-18 percent range based on the projected mix of aircraft deliveries and operational efficiencies realized to date.

Combat Systems

 

Three Months Ended    June 29
2008
    July 1
2007
    Variance  

Net sales

   $ 2,015     $ 1,712     $ 303    17.7 %

Operating earnings

     282       191       91    47.6 %

Operating margin

     14.0 %     11.2 %             
Six Months Ended    June 29
2008
    July 1
2007
    Variance  

Net sales

   $ 4,012     $ 3,280     $ 732    22.3 %

Operating earnings

     541       365       176    48.2 %

Operating margin

     13.5 %     11.1 %             

The Combat Systems group’s net sales increased significantly in the second quarter and first half of 2008 compared with 2007. Approximately 75 and 85 percent of the group’s sales growth in the second quarter and first half of 2008, respectively, resulted from increased volume in the group’s U.S. military vehicle business. Sales grew 24 percent in this business in the second quarter and 37 percent in the first half of 2008 compared with the same prior-year periods. The group’s contracts to produce RG-31 and Cougar armored vehicles under the mine-resistant, ambush-protected (MRAP) vehicle program were the primary driver of the sales growth. The group expects sales under this program to decline significantly in the second half as it completes the scheduled deliveries under its current contracts. A follow-on contract awarded in July 2008 is expected to extend deliveries of RG-31s under this program beginning in December 2008 and continuing until April 2009. Increased activity on a number of the company’s long-term platform programs also contributed to the group’s sales growth. These included several contracts in support of the Abrams main battle tank, most notably the System Enhancement Package (SEP) upgrade and the M1A1 reset programs.

Sales in the group’s weapons systems business were steady in the second quarter of 2008, but year-to-date sales grew 8 percent. Increased deliveries of systems that protect U.S. combat forces from improvised explosive devices was the primary driver of the sales growth in first six months of 2008, but volume on this contract was down in the second quarter compared with the same period in 2007. This decline in the quarter was offset by increased activity on the group’s contract to produce Hydra-70 rockets.

Volume in the group’s munitions business increased 10 percent in the second quarter and 7 percent in the first half of 2008 over the same periods in 2007. The sales growth was driven by increased sales of large-caliber ammunition products to the Canadian government and medium-caliber ammunition to the U.S. government.

 

-28-


Table of Contents

The group’s European military vehicle business generated sales growth of 21 percent and 4 percent in the second quarter and first six months of 2008, respectively. The increased sales resulted primarily from higher volume on the Pandur II wheeled vehicle contract for Portugal and the Piranha wheeled armored vehicle contract for Belgium, as well as increased activity in the group’s mobile bridge business. The group’s sales growth in the first half of 2008 was tempered by lower activity on the Leopard battle-tank program with the Spanish government.

In the second quarter of 2008, the company entered into a memorandum of understanding and a testing agreement with the Czech Republic regarding the testing and acceptance of 17 Pandur II vehicles completed by the group under a contract for 199 vehicles. These agreements are part of ongoing negotiations between the company and the Czech Republic following a notice of termination delivered by the customer in December 2007. The parties are negotiating a revised contract for the purchase of 107 vehicles, including the 17 completed vehicles. The company does not believe the outcome of the negotiations will have a material effect on the group’s operating results.

The Combat Systems group’s operating earnings increased almost 50 percent in the second quarter and first half of 2008, resulting in a 280 basis point improvement in operating margins in the quarter and 240 basis point increase year-to-date over the same periods in 2007. The earnings growth came from across the portfolio as three of the group’s four businesses generated increases in both earnings and margins over the second quarter and first half of 2007. Among these, the most significant contributor was the group’s U.S. military vehicle business, most notably on the MRAP and Abrams programs.

The company expects full-year top-line growth for Combat Systems in the 9 to 10 percent range as declining volume on the MRAP program is replaced by growth in other areas of the group’s business. As a result of this mix shift, the company expects somewhat lower margins in the second half of the year, with full-year margins approaching 13 percent.

Marine Systems

 

Three Months Ended    June 29
2008
    July 1
2007
    Variance  

Net sales

   $ 1,394     $ 1,272     $ 122    9.6 %

Operating earnings

     127       112       15    13.4 %

Operating margin

     9.1 %     8.8 %             
Six Months Ended    June 29
2008
    July 1
2007
    Variance  

Net sales

   $ 2,772     $ 2,529     $ 243    9.6 %

Operating earnings

     249       210       39    18.6 %

Operating margin

     9.0 %     8.3 %             

 

-29-


Table of Contents

The Marine Systems group produced strong net sales growth in the second quarter and first half of 2008 compared with 2007. Approximately 60 percent of the group’s sales in each period were generated by three of the group’s mature ship-production programs for the U.S. Navy – the Virginia-class submarine, the Arleigh Burke-class (DDG-51) destroyer and the T-AKE combat-logistics ship. The combined volume on these three programs contributed approximately 50 percent of the sales growth in both the second quarter and first six months of 2008, driven by growth in the Virginia-class program. Activity has increased significantly on this program in 2008 as construction continues on all six ships under the fixed-price Block II contract with deliveries scheduled through 2013. The fourth and final ship of the cost-reimbursable Block I contract was delivered in the first quarter of 2008, and the first Block II ship is scheduled to be delivered in the third quarter of 2008. The company expects to finalize negotiations for an eight-ship Block III contract by the end of 2008. Volume has been flat on the T-AKE program in 2008 compared with 2007. Construction is in progress on the sixth through ninth of the 10 ships currently under contract. The group delivered the fifth ship in the second quarter of 2008, and the sixth is scheduled to be delivered later this year. Activity on the destroyer program decreased slightly in the second quarter and first half of 2008 as the group delivered its 29th ship in the first quarter and construction continued on the remaining five ships under contract. The next destroyer is scheduled to be delivered in the second half of 2008.

Supplementing the volume from these mature ship-construction programs, commercial shipbuilding activity increased significantly in 2008. Construction continued on the first two of nine product carrier ships under contract, and the increased volume on this program contributed almost 40 percent of the group’s sales growth in the second quarter and first six months of 2008. Volume was also up on the group’s design and early-stage construction programs for the Navy, including the DDG-1000 next-generation destroyer and the Littoral Combat Ship. The group was almost 70 percent complete with the detail design of the DDG-1000 and approximately 80 percent complete with construction of its Littoral Combat Ship at the end of the second quarter. Combined activity on these two programs increased approximately 30 percent and 45 percent in the second quarter and first six months of 2008, respectively, over the same prior-year periods. Volume on the group’s engineering, repair and overhaul programs for the Navy increased 9 percent in the second quarter and 7 percent in the first half of 2008. The volume increases in the group were offset slightly by the completion of the group’s SSGN submarine conversion contract in the fourth quarter of 2007.

The Marine Systems group’s operating earnings and margins grew significantly in 2008 compared to 2007. The group’s margins increased 30 basis points in the second quarter and 70 basis points year-to-date as the group continues to improve its performance by achieving increased operating efficiencies at each of its shipyards. The most notable contributors to the earnings and margin growth were the Virginia-class, Arleigh Burke and T-AKE programs, each of which has generated substantial labor efficiencies, resulting in higher program earnings rates. The earnings growth driven by improvements in these programs was offset in part by lower earnings on the SSGN program.

The company expects the Marine Systems group’s full-year 2008 sales to increase by 7 to 8 percent over 2007 as it continues to make progress on the substantial backlog in each of its yards. The company expects full-year operating margins in the group to reach 9 percent as the group pursues further efficiencies on its ship-construction programs.

 

-30-


Table of Contents

Information Systems and Technology

 

Three Months Ended    June 29
2008
    July 1
2007
    Variance  

Net sales

   $ 2,565     $ 2,399     $ 166    6.9 %

Operating earnings

     292       269       23    8.6 %

Operating margin

     11.4 %     11.2 %             
Six Months Ended    June 29
2008
    July 1
2007
    Variance  

Net sales

   $ 4,916     $ 4,780     $ 136    2.8 %

Operating earnings

     552       519       33    6.4 %

Operating margin

     11.2 %     10.9 %             

The Information Systems and Technology group’s sales were up in both the second quarter and first six months of 2008. Combined sales in the group’s tactical communications and core defense information technology (IT) services businesses were up 13 percent in the second quarter and 8 percent in the first half of the year over the same periods in 2007. This growth was driven by increased volume on the group’s ground-based satellite communications programs and contracts that support the U.S. military and intelligence communities around the world, including the following significant programs:

 

   

Warfighter Information Network – Tactical (WIN-T), which provides warfighters fast, secure, mobile command-and-control capabilities;

 

   

Common Hardware/Software III (CHS-3), which provides commercial and ruggedized computers, network equipment and software to the U.S. armed forces and other U.S. federal agencies worldwide;

 

   

Combat Operations Centers (COC), which are mobile command-and-control systems used in Iraq; and

 

   

Network-Centric Solutions (NETCENTS), which provides network-centric IT, networking, communications products, system solutions, and system hardware and software to federal agencies.

Reduced demand in the commercial wireless market within the IT services business continued to be a drag on the group’s sales growth in 2008. Volume within the wireless business decreased more than 35 percent in the second quarter and first six months of 2008 compared with 2007. Sales volume in the group’s intelligence business stabilized in the second quarter of 2008 following several quarters of declining revenue as funding for programs in this area was deferred in favor of other priorities. In the group’s United Kingdom operation, sales decreased 3 percent and 9 percent in the second quarter and first six months of 2008, respectively, due largely to the scheduled transition of the BOWMAN communications program to maintenance and long-term support activities. While the BOWMAN program’s volume was down compared to 2007, the program has reached a steady-state level of volume for the foreseeable future.

The Information Systems and Technology group’s operating earnings and margins improved in 2008 compared to 2007. Operating margins increased by 20 basis points in the quarter and 30 basis points year-to-date as the group’s tactical communications, intelligence systems and United Kingdom businesses each improved their operating performance.

 

-31-


Table of Contents

The company expects full-year 2008 sales growth for the group in the mid-single-digit range. The company expects the group’s operating margins for the full year to be 10 to 20 basis points lower than 2007 because of an increase in the proportion of services volume in the second half of the year, with some opportunity for upside based on program performance.

Corporate

Corporate results consist primarily of the company’s stock option expense and a portion of the results of the company’s commercial pension plans. Corporate operating expenses totaled $20 in second quarter 2008 compared with $11 in second quarter 2007. Year-to-date corporate operating expenses were $36 in the first six months of 2008 compared with $25 in the same period in 2007. The increase in both periods resulted from higher stock option expense. The company expects 2008 stock option expense of approximately $75.

Backlog

The following table details the backlog and the total estimated contract value of each business group at the end of the second and first quarters of 2008:

 

June 29, 2008    Funded    Unfunded    Total
Backlog
   Estimated
Potential
Contract
Value
   Total
Estimated
Contract
Value

Aerospace

   $ 18,195    $ 634    $ 18,829    $ 2,309    $ 21,138

Combat Systems

     10,611      3,263      13,874      2,610      16,484

Marine Systems

     8,899      3,239      12,138      2,167      14,305

Information Systems and Technology

     7,531      2,950      10,481      10,348      20,829

Total

   $ 45,236    $ 10,086    $ 55,322    $ 17,434    $ 72,756
March 30, 2008                              

Aerospace

   $ 11,802    $ 650    $ 12,452    $ 926    $ 13,378

Combat Systems

     11,116      3,171      14,287      2,292      16,579

Marine Systems

     9,552      3,056      12,608      2,272      14,880

Information Systems and Technology

     7,582      2,838      10,420      9,142      19,562

Total

   $ 40,052    $ 9,715    $ 49,767    $ 14,632    $ 64,399

Defense Businesses

The total backlog for the company’s defense businesses represents the estimated remaining sales value of work to be performed under firm contracts. The funded portion of this backlog includes items that have been authorized and appropriated by the Congress and funded by the customer, as well as commitments by international customers that are similarly approved and funded by their governments.

 

-32-


Table of Contents

The unfunded backlog represents firm orders that do not meet these criteria. While there is no guarantee that future budgets and appropriations will provide funding for a given program, the company has included in backlog only firm contracts it believes are likely to receive funding. The backlog does not include work awarded under unfunded indefinite delivery, indefinite quantity (IDIQ) contract awards or unexercised options. The estimated potential contract value represents management’s estimate of the future contract value to the company under these arrangements.

IDIQ contracts are used when the customer has not defined the exact timing and quantity of deliveries that will be required at the time the contract is executed. These agreements, which set forth the majority of the contractual terms, including prices, are funded when delivery orders are placed. A significant portion of the company’s IDIQ value represents contracts for which the company has been designated as the sole-source supplier to design, develop, produce and integrate complex products and systems over several years for the military or other government agencies. Management believes the customers intend to fully implement these systems. However, because the value of these arrangements is subject to the customer’s future exercise of an indeterminate quantity of delivery orders, the company recognizes these contracts in backlog only when they are funded.

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

Total orders received in the company’s defense businesses during the second quarter of 2008 were $4.7 billion. The orders in the second quarter included several notable contract awards.

Combat Systems awards included the following:

 

   

$139 from the Canadian government for Optimized Weapons Systems Support for the Wheeled Light Armoured Vehicle (WLAV). This contract has a potential value of approximately $370.

 

   

$116 from the U.S. Army for long-lead materials to reset 204 M1A1 Abrams Integrated Management (AIM) main battle tanks.

 

   

Combined orders worth $88 from the Army to continue performing contractor logistics support for the Stryker program.

 

   

$58 from the Army for long-lead materials for the production of Stryker Infantry Carrier Vehicle and Nuclear, Biological and Chemical Reconnaissance Vehicle variants.

Marine Systems awards included the following:

 

   

$132 from the U.S. Navy for Post Shakedown Availability (PSA) work for six Virginia-class Block II submarines.

 

-33-


Table of Contents
   

$100 from the Navy to purchase long-lead materials for the 12th T-AKE combat-logistics ship.

Information Systems and Technology awards included the following:

 

   

$116 to build the spacecraft for NASA’s Landsat Data Continuity Mission.

 

   

Combined orders totaling $115 under the Common Hardware/Software III program, bringing the total contract value to approximately $1.3 billion.

 

   

$114 to develop and integrate the maritime and fixed-site joint tactical radio capabilities and provide information assurance services for the Airborne, Maritime and Fixed Site (AMF) Joint Tactical Radio System (JTRS). The contract has a potential value of over $150.

 

   

$77 to provide life-cycle contractor support and training support for the Warfighter Field Operations Customer Support (FOCUS) program. This contract has a potential value of approximately $2 billion.

The company has also received significant contract awards since the end of the second quarter, including a contract award in Combat Systems with a total potential value of over $550 to produce 773 RG-31 vehicles for the MRAP program. Production is scheduled to begin in the fourth quarter of 2008 and continue through the second quarter of 2009. The Information Systems and Technology group also received an award worth $850 under the Intelligence Information, Command-and-Control Equipment and Enhancements (ICE2) program, bringing the total contract value to over $3 billion.

Aerospace

The Aerospace funded backlog represents orders for which the company has definitive purchase contracts and deposits from the customer. The Aerospace unfunded backlog consists of agreements to provide future aircraft maintenance and support services. The Aerospace potential contract value represents options to purchase new aircraft.

In the second quarter of 2008, order activity continued to be strong across the Aerospace group’s product portfolio. In particular, the group began taking orders for the Gulfstream G650, a new ultra-long-range, ultra-large-cabin business jet that is scheduled to enter service in the second quarter of 2012. Demand for this new product has been very strong, and the group received $7.5 billion in total new orders for all new aircraft models in the quarter. Excluding the G650 orders in the second quarter, the group maintained a book-to-bill ratio (orders divided by sales) greater than one for the ninth consecutive quarter. Including G650 orders, the group’s new-aircraft book-to-bill in the quarter was 6.6.

In the second quarter of 2008, the company signed an amendment to its contract with NetJets Inc. worth approximately $1.9 billion for options to supply eight large-cabin aircraft per year between 2012 and 2016 and related maintenance. The value of the aircraft options in this agreement have been included in the group’s potential contract value and will be included in backlog as the options are exercised by the customer.

 

-34-


Table of Contents

Financial Condition, Liquidity and Capital Resources

Operating Activities

General Dynamics continued to generate strong cash flow from operating activities in the first six months of 2008. Net cash provided by operating activities increased by $532 to $1.5 billion in the first six months of 2008 compared with $919 in the same period in 2007. The two primary drivers of the increased cash flow in 2008 were the growth in company’s earnings from continuing operations of $256 and an increase in non-refundable customer deposits in the Aerospace group from the group’s significant order activity. The company ended the second quarter of 2008 with a cash balance of $2.7 billion compared with $2.9 billion at the end of 2007.

As discussed further in Note J to the unaudited Consolidated Financial Statements, litigation on the A-12 contract termination has been ongoing since 1991. If, contrary to the company’s expectations, the default termination ultimately is sustained, the company and 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 $1.4 billion at June 29, 2008. If this were the outcome, the government contends the company would owe approximately $1.4 billion pretax. The company’s after-tax cash obligation would be approximately $680. The company believes it has sufficient resources to pay such an obligation, if required, while still retaining ample liquidity.

Investing Activities

Net cash used for investing activities was $296 for the six-month period ended June 29, 2008, compared with $379 in the same period in 2007. The primary uses of cash in investing activities were business acquisitions and capital expenditures. As discussed further in Note B to the unaudited Consolidated Financial Statements, in the first six months of 2008, the company completed one acquisition for approximately $65 in cash. In the first half of 2007, the company completed two acquisitions for an aggregate of approximately $300 in cash. The company used cash on hand to fund these acquisitions. The company expects full-year capital expenditures to be between 1.5 and 2 percent of net sales.

In July 2008, the company completed its acquisition of ViPS, Inc., a healthcare technology solutions company, for approximately $225. The company financed the transaction using cash on hand.

Financing Activities

Financing activities used net cash of $1.3 billion in the first half of 2008 compared with $350 in the same period in 2007. The company’s typical 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.

In the first half of 2008, the company repaid $500 of fixed-rate debt on the scheduled maturity date. There were no significant debt repayments in the first six months of 2007. In the second half of 2008, $150 of senior notes and $20 of term debt are scheduled to mature. The company expects to use cash on hand to repay this indebtedness on maturity.

 

-35-


Table of Contents

On March 5, 2008, the company’s board of directors declared an increase in the company’s regular quarterly dividend to $0.35 per share – the 11th consecutive annual increase. The board had previously increased the regular quarterly dividend to $0.29 per share in March 2007.

In the first six months of 2008, the company repurchased approximately 8.3 million shares at an average price of about $84 per share. In the first half of 2007, the company repurchased approximately 2 million shares at an average price of about $76 per share. As of June 29, 2008, the company had 1.2 million remaining shares authorized for repurchase.

Free Cash Flow

Free cash flow from operations for the first six months of 2008 was $1.3 billion compared with $761 for the same period in 2007. Management defines free cash flow from operations as net cash provided by operating activities from continuing operations less capital expenditures. Management believes free cash flow from operations is a useful measure for investors, because it portrays the company’s ability to generate cash from its core businesses for purposes such as repaying maturing debt, funding business acquisitions, repurchasing its common stock and paying dividends. The company uses free cash flow from operations to assess the quality of its earnings and as a performance measure in evaluating management. The following table reconciles free cash flow from operations with net cash provided by operating activities from continuing operations, as classified on the unaudited Consolidated Statement of Cash Flows:

 

Six Months Ended    June 29
2008
    July 1
2007
 

Net cash provided by operating activities from continuing operations

   $ 1,456     $ 927  

Capital expenditures

     (200 )     (166 )

Free cash flow from operations

   $ 1,256     $ 761  

Cash flows as a percentage of earnings from continuing operations:

    

Net cash provided by operating activities from continuing operations

     120 %     97 %

Free cash flow from operations

     103 %     79 %

With free cash flow from operations projected to exceed earnings from continuing operations for the full-year 2008, General Dynamics expects to continue to generate funds from operations in excess of its short- and long-term liquidity needs. Management believes that the company has adequate funds on hand and sufficient borrowing capacity to execute its financial and operating strategy.

Additional Financial Information

Environmental Matters and Other Contingencies

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

 

-36-


Table of Contents

Application of Critical Accounting Policies

Management’s Discussion and Analysis of the company’s Financial Condition and Results of Operations is based on the company’s unaudited Consolidated Financial Statements, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, management evaluates its estimates, including those related to long-term contracts and programs, goodwill and other intangible assets, income taxes, pensions and other post-retirement benefits, workers’ compensation, warranty obligations, and contingencies and litigation. Management bases its estimates on historical experience and on various other assumptions that it believes to be reasonable under the circumstances. The results of these estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily available from other sources. Actual results may differ from these estimates under different assumptions or conditions. For a full discussion of the company’s critical accounting policies, see the company’s Annual Report on Form 10-K for the year ended December 31, 2007.

New Accounting Standards

In May 2008, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 162, The Hierarchy of Generally Accepted Accounting Principles. SFAS 162 transfers the hierarchy of GAAP from the auditing literature to the accounting standards and identifies a consistent hierarchy for selecting accounting principles to be used in applying U.S. GAAP. SFAS 162 is effective 60 days following the SEC’s approval of PCAOB Auditing Standard No. 6, Evaluating Consistency of Financial Statements (AS/6). The company does not expect the adoption of SFAS 162 to have any effect on its results of operations, financial condition or cash flows.

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities – An Amendment of FASB Statement No. 133. SFAS 161 expands and enhances required disclosures related to derivatives and hedging instruments. SFAS 161 is effective in the first quarter of 2009. The company does not expect the adoption of SFAS 161 to have a material effect on its results of operations, financial condition or cash flows.

In December 2007, the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements - An Amendment of ARB No. 51. SFAS 160 establishes new accounting for noncontrolling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 is effective in the first quarter of 2009. The company does not expect the adoption of SFAS 160 to have a material effect on its results of operations, financial condition or cash flows.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations. SFAS 141R changes the requirements for accounting for business combinations, including the determination of purchase price and assignment of purchase price to acquired assets and assumed liabilities. SFAS 141R is effective for acquisitions that are completed after December 31, 2008. The company is currently analyzing the expected impact of the adoption of this standard on future acquisitions.

 

-37-


Table of Contents

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no material changes with respect to this item from the disclosure included in the company’s Annual Report on Form 10-K for the year ended December 31, 2007.

ITEM 4. CONTROLS AND PROCEDURES

The company’s management, under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of the company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of June 29, 2008. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of June 29, 2008, the company’s disclosure controls and procedures were effective.

There were no changes in the company’s internal control over financial reporting that occurred during the quarter ended June 29, 2008, that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.

 

-38-


Table of Contents

FORWARD-LOOKING STATEMENTS

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

expected recovery on contract claims and requests for equitable adjustment;

 

   

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

 

   

potential for changing prices for energy and raw materials; and

 

   

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

All forward-looking statements speak only as of the date of this report or, in the case of any document incorporated by reference, the date of that document. All subsequent written and oral forward-looking statements attributable to the company or any person acting on the company’s behalf are qualified by the cautionary statements in this section. The company does 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.

 

-39-


Table of Contents

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS

There have been no material changes with respect to this item from the disclosure included in the company’s Annual Report on Form 10-K for the year ended December 31, 2007.

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

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

 

Period    Total Number
of Shares
Purchased
  

Average Price

Paid per Share

   Total Number of
Shares Purchased as
Part of Publicly
Announced Program *
   Maximum Number of
Shares that May yet
Be Purchased Under
the Program *

3/31/08 - 4/27/08

   —      $ —      6,696,900    3,303,100

4/28/08 - 5/25/08

   —      $ —      6,696,900    3,303,100

5/26/08 - 6/29/08

   2,060,000    $ 85.33    8,756,900    1,243,100
             

Total

   2,060,000    $ 85.33      
             

 

*

On December 5, 2007, the board of directors authorized management to repurchase up to 10 million shares of common stock in the open market. Unless terminated earlier by resolution of the board of directors, the program will expire when the number of authorized shares has been repurchased.

The company did not make any unregistered sales of equity securities in the second quarter.

 

-40-


Table of Contents

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

(a) The Annual Meeting of Shareholders of the company, for which proxies were solicited pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, was held on May 7, 2008.

 

(b) In an uncontested election, each of the following nominees was elected to the Board of Directors according to the following votes:

 

Matter    Votes Cast
     For    Against    Abstain    Broker
Non-votes

Election of Directors:

           

N.D. Chabraja

   349,306,741    18,266,184    3,365,460    —  

J.S. Crown

   339,054,405    28,380,856    3,503,124    —  

W.P. Fricks

   352,481,689    15,062,449    3,394,247    —  

C.H. Goodman

   348,299,612    19,192,396    3,446,377    —  

J.L. Johnson

   352,358,511    15,056,958    3,522,916    —  

G.A. Joulwan

   352,468,945    15,044,805    3,424,635    —  

P.G. Kaminski

   352,666,934    14,876,291    3,395,160    —  

J.M. Keane

   351,454,138    15,006,916    4,477,331    —  

D.J. Lucas

   340,640,892    26,727,306    3,570,187    —  

L.L. Lyles

   351,340,963    15,105,675    4,491,747    —  

C.E. Mundy, Jr.

   352,210,511    15,297,403    3,430,471    —  

J.C. Reyes

   366,507,827    1,009,407    3,421,151    —  

R. Walmsley

   352,577,349    14,927,158    3,433,878    —  

 

(c) The results of voting on Proposals 2 through 4 (as numbered in the company’s 2008 Proxy Statement) were as follows:

Proposal 2. Shareholders approved the selection of KPMG LLP as the company’s independent auditors for 2008.

 

     For    Against    Abstain    Broker
Non-votes

Approval of KPMG as Independent Auditors

   365,197,600    2,873,417    2,867,368    —  

Proposal 3. A shareholder proposal requesting that the Board of Directors review and, if necessary, amend and amplify the Company’s code of conduct and statement of ethical criteria for military production-related contract bids, awards and contract execution did not receive a majority of the votes cast.

 

-41-


Table of Contents
     For    Against    Abstain    Broker
Non-votes

Shareholder Proposal with regard to Ethical Criteria for Military Contracts

   12,479,277    282,612,697    46,676,314    29,170,097

Proposal 4. A shareholder proposal requesting that the Board of Directors amend the Company’s bylaws in order that there be no restriction on the shareholder right to call a special meeting did not receive a majority of votes cast.

 

     For    Against    Abstain    Broker
Non-votes

Shareholder Proposal with regard to Special Shareholder Meetings

   103,871,231    230,166,813    7,730,244    29,170,097

 

-42-


Table of Contents

ITEM 6. EXHIBITS

 

10.1    Employment Agreement between the company and Jay L. Johnson dated May 7, 2008
31.1    Certification by CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2    Certification by CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1    Certification by CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2    Certification by CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

-43-


Table of Contents

SIGNATURES

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

 

GENERAL DYNAMICS CORPORATION
by  

/s/ John W. Schwartz

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