UNITED STATES SECURITIES AND EXCHANGE COMMISSION
FORM 10-K
Commission file number 1-3671
Registrant’s telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K. Yes þ
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ No o
The aggregate market value of the voting common equity held by nonaffiliates of the registrant was $13,094,497,759 as of June 29, 2003 (based on the closing price of the shares on the New York Stock Exchange).
198,200,263 shares of the registrant’s common stock were outstanding at January 31, 2004.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III incorporates information from certain portions of the registrant’s definitive proxy statement for the 2004 annual meeting of shareholders to be filed with the Securities and Exchange Commission within 120 days after the close of the fiscal year.
TABLE OF CONTENTS
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K 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, which 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, which 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:
PART I
ITEM 1. BUSINESS
BUSINESS OVERVIEWGeneral Dynamics is a market leader in mission-critical information systems and technologies; land and expeditionary combat vehicles, armaments and munitions; shipbuilding and marine systems; and business aviation. Incorporated in Delaware, the company employs approximately 67,600 people and has a presence worldwide. Formed in 1952 through the combination of Electric Boat Company, Consolidated Vultee and other entities, the company grew through internal development and acquisitions but was largely dismantled in the early 1990s through the sale of all of its divisions except Electric Boat and Land Systems. The company’s present composition is the result of a series of acquisitions begun in 1995. At that time, General Dynamics began an expansion of its two core defense businesses, broadening its product lines through the acquisition of other shipyards and combat vehicle-related entities. The company also added information technology products and services, particularly in the command-and-control, communications, computing, intelligence, surveillance and reconnaissance (C4ISR) area, and business-jet aircraft and aviation support services to its offerings. Since 1995, General Dynamics has acquired more than 30 businesses, including seven during 2003. General Dynamics’ management focus is creating shareholder value while providing the best products and services possible to its customers, both military and commercial. The company emphasizes excellence in program management through continuous operational improvements and ethical business practices. This culture is evident in how the company deals with shareholders, employees, customers, partners and communities. General Dynamics is organized into four primary business groups: Information Systems and Technology, Combat Systems, Marine Systems and Aerospace. These groups design, develop, manufacture and support leading-edge technology, products and services for use across the spectrum of military operations. From nuclear submarines to Stryker armored infantry carriers, ammunition to targeting systems, tactical Personal Digital Assistants to combat search-and-rescue radios, General Dynamics supports the combat warrior on land, at sea, in the air and on the network. The company’s Gulfstream business-jet aircraft serve business travelers around the world, as well as government customers as special mission platforms for intelligence, surveillance, reconnaissance and transport. In addition to the four principal business groups, a small Resources group provides construction aggregates and operates coal mines. Following is a description of the company’s products and services by business group, competition and other related information.
PRODUCTS AND SERVICES
INFORMATION SYSTEMS AND TECHNOLOGYThe Information Systems and Technology group is a leading integrator of secure communications systems and networks; command, control and intelligence systems; special purpose computing; and surveillance and reconnaissance systems for the U.S. military, the U.S. intelligence community and allied nations. The group supplies products, infrastructure and integration services that are used to gather, process and disseminate information rapidly and accurately. The group provides a full spectrum of information and communications technologies, including:
COMBAT SYSTEMSAs a leading provider of tracked and wheeled armored combat vehicles, armament systems and ammunition in North America, Europe and the South Pacific, and the only producer of America’s main battle tanks, the Combat Systems group delivers key products and technologies to U.S. and allied military forces. The group is one of the preferred suppliers of land and expeditionary combat system development, production and support around the world. Combat Systems conceives, engineers, manufactures and supports product lines that include a full spectrum of armored vehicles, trucks and light wheeled vehicles, bridges, suspensions, engines, transmissions, guns and ammunition handling systems, turret and turret-drive systems, reactive armor, chemical and biohazard detection products, ammunition and ordnance, and composite manufacturing. During 2003, the Combat Systems group enhanced its product offerings and engineering and production capabilities through three acquisitions, expanding the group’s customer base and its relationships with existing customers:
MARINE SYSTEMSThe Marine Systems group has three shipyards with a long, proud history of providing the Navy with ships and submarines used to project the United States’ presence around the globe. Electric Boat manufactured the Navy’s first submarine more than 100 years ago. The company’s two other shipyards have demonstrated decades of innovation in developing destroyers and auxiliary ships for the Navy. Today, the group is on the cutting edge of shipbuilding as it participates in the design, development, manufacture and integration of the complex platforms that are central to Seapower 21, the Navy’s transformation vision. With its experience and expertise in the development of surface, sub-surface and support platforms, Marine Systems is a key partner with the Navy. Marine Systems is leading the development of the new Virginia-class submarines, for which it received the largest submarine order in U.S. history. Construction work on the Virginia-class submarine is shared equally with the company’s teaming partner. The Virginia Class will provide the Navy a key platform with stealth, firepower and endurance, networked for communication with strategic and surface forces, in its pursuit of undersea superiority. Complementing this platform will be the Trident SSGN submarines, which the group is developing through the conversion of four Trident ballistic-missile submarines. The Trident SSGNs will be multi-mission submarines optimized for tactical strike and special operations support, key capabilities for future engagements around the world. The group is the lead designer and producer of Arleigh Burke-class guided-missile destroyers, one of the most advanced surface combatants in the world. It is also one of three competitors developing preliminary designs for the Navy’s Littoral Combat Ship (LCS). The LCS platform is intended for defense against terrorist swarm boats, mines and submarine threats in coastal areas.
AEROSPACEThe Aerospace group designs, develops, manufactures, markets and supports a fleet of world-renowned business-jet aircraft, and provides aviation services for business-jet aircraft. The group was created in 1999 when the company acquired Gulfstream Aerospace Corporation. In 2001, the group added mid-size aircraft to its product offerings with the acquisition of Galaxy Aerospace Company, and formed a separate aviation services unit. Gulfstream has produced more than 1,400 aircraft for customers around the world since 1958. In 2003, the group broadened its offering of business-jet aircraft by introducing a new aircraft and completing regulatory requirements for production of other airframes. In addition, the group expanded its aviation services operations to include the first Gulfstream-owned service center outside the United States through an acquisition at the London Luton Airport in the United Kingdom. The new large-cabin, long-range Gulfstream G450, introduced in 2003, is an entire aircraft upgrade of the best-selling business jet in its class — the Gulfstream GIV/GIV-SP/G400. The G450 incorporates the most advanced avionics, cockpit displays, aircraft systems, aerodynamic enhancements and flight safety features, and retains the aesthetic design and signature windows that set Gulfstream aircraft apart from competing models. The new G450, which is expected to receive certification later this year, was designed for safety, performance, reliability, and passenger comfort and productivity. The group received Federal Aviation Administration (FAA) type and production certification for the Gulfstream G550 model on August 14, 2003. The large-cabin, ultra-long-range G550 can fly as high as 51,000 feet and can travel at speeds up to Mach .885 and distances up to 6,750 nautical miles — the longest range available in a business jet. In February 2004, the National Aeronautic Association awarded its Collier Trophy to the G550, naming it “the greatest achievement in aeronautics in the United States with respect to improving performance, efficiency or safety of air or space vehicles” in 2003. The Aerospace group also received type certification for its state-of-the-art PlaneView® cockpit, as well as the first production certification for the Gulfstream Enhanced Vision System (EVS). The Gulfstream EVS significantly improves pilot situational awareness during conditions of reduced visibility, both in flight and on the ground. Additionally, in February 2004, the company further expanded its product line by introducing the Gulfstream G350 model. Very similar in design to the G450, the new aircraft delivers the same spacious cabin, advanced avionics and cockpit systems, exceptional performance and reliability, but with a slightly reduced range and a lower price. Looking beyond the commercial market, the group continued efforts to offer its aircraft as platforms for ISR and other special mission applications by U.S. and allied governments. It sold four G550 aircraft to the Israeli Ministry of Defense for use as Compact Airborne Early Warning (CAEW) platforms, which will take full advantage of the G550’s capabilities, endurance, reliability and low operating cost. Additionally, the G450 was designated the platform of choice by one of the two competitors in a pending U.S. military procurement for special mission ISR applications. The company formed General Dynamics Aviation Services in February 2001 to better meet the maintenance needs of a variety of the most popular business-jet aircraft available around the world. It serves a broad range of business-aircraft owners through maintenance centers in Minneapolis, Minnesota; Westfield, Massachusetts; West Palm Beach, Florida; Dallas, Texas; and Las Vegas, Nevada. With an expanded product line, the company believes the Aerospace group is well positioned to take advantage of an encouraging market.
RESOURCESThe Resources group includes two businesses: a coal mining operation and an aggregates operation that mines sand, stone and gravel for use in highway and building construction. Net sales for these businesses represented approximately 1 percent of the company’s consolidated net sales in 2003 and 2 percent in 2002 and 2001. Net sales were $256 in 2003, $286 in 2002 and $276 in 2001.
For additional discussion of the company’s business groups, including significant program wins in 2003, see Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of this Annual Report on Form 10-K. For information on the revenues, operating earnings and identifiable assets attributable to each of the company’s business groups, see Note R to the Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K.
COMPETITION
The company’s ability to compete successfully depends on the technical excellence and reliability of its products and services, its reputation for integrating complex systems, its leadership team’s successful management of the company’s businesses and customer relationships, and the cost competitiveness of its products and services. The company competes in two separate markets: defense and business-jet aircraft.
DEFENSE MARKETThe defense market is served by numerous domestic and foreign companies that offer a range of products and services and compete with the company for many of its contracts. On occasion, the company is involved in subcontracting relationships with some of these competitors. The key competitive factors in this market are technological innovation, low-cost production, performance and market knowledge. The Information Systems and Technology group competes with a broad range of entities, from large defense companies to smaller niche competitors with specialized technologies. The Combat Systems group competes in a market composed primarily of large domestic and foreign entities. The company partners with some of these entities from time to time, and currently is in a teaming arrangement with another U.S. defense contractor on the manned vehicle portion of the FCS program. The Marine Systems group operates in a market with only one other primary competitor, Northrop Grumman Corporation; the company is also teamed with that competitor on several programs, including the Virginia-class submarine construction contract. The Navy’s LCS program has increased competition to now include other large aerospace companies seeking opportunities as shipbuilding prime contractors.
BUSINESS-JET AIRCRAFT MARKETCompetition in the business-jet aircraft market generally is divided into segments based on the cabin size, range and price of the aircraft. Aerospace offers a total of nine products in the following market segments:
The company has at least one competitor in each market segment in which it competes. The number of competitors increases in the segments that offer shorter ranges. The key competitive factors in the business-jet market are the performance characteristics of the aircraft, the quality and timeliness of the service provided, the advances in technology offered, and innovative marketing programs, including price. The company believes it competes favorably on these criteria.
CUSTOMERS
The company’s primary customer is the U.S. government, particularly the Department of Defense. In 2003, 66 percent of the company’s net sales were to the U.S. government; 18 percent were to U.S. commercial customers; 11 percent were directly to international defense customers; and the remaining 5 percent were to international commercial customers.
U.S. GOVERNMENTThe company’s net sales to the U.S. government were as follows:
U.S. COMMERCIALThe company’s commercial sales were $3,009 in 2003, $3,235 in 2002 and $3,555 in 2001. These sales represented approximately 18 percent of the company’s consolidated net sales in 2003, 23 percent in 2002 and 29 percent in 2001. The majority of these sales were for Gulfstream aircraft, primarily to Fortune 500®companies and large, privately held companies. The aircraft are operated by customers in a wide range of industries.
INTERNATIONALThe company’s direct (non-Foreign Military Sales) sales to defense and commercial customers outside the United States were $2,581 in 2003, $1,788 in 2002 and $1,180 in 2001. These sales represented approximately 16 percent of the company’s consolidated net sales in 2003, 13 percent in 2002 and 10 percent in 2001. International defense sales were primarily from the company’s subsidiaries located abroad; international commercial sales were primarily exports of business-jet aircraft. The company has operations in Australia, Austria, Canada, Germany, Spain, Switzerland and the United Kingdom. Sales from these international operations were $2,175 in 2003, $970 in 2002 and $421 in 2001. The long-lived assets of operations located outside the United States were 16 percent of the company’s total as of December 31, 2003, 6 percent as of December 31, 2002, and 5 percent as of December 31, 2001. For information regarding sales by geographic region, see Note R to the Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K.
SUPPLIERS
In some cases, the company is dependent upon suppliers and subcontractors for raw materials and components used in the production of its products. In some instances, the company relies on only one or two
RESEARCH AND DEVELOPMENT
The company conducts independent research and development (R&D) activities. The company also conducts R&D activities under U.S. government contracts to develop products for large systems-development and technology programs. The majority of company-sponsored R&D expenditures in each of the past three years was in the company’s defense business. The company recovers a significant portion of these expenditures through overhead charges pursuant to U.S. government contracts. The R&D activities of the Aerospace group consist primarily of internally funded product enhancement and development programs for Gulfstream aircraft. Research and development expenditures were as follows:
BACKLOG
The company’s total backlog represents the estimated remaining sales value of work to be performed under firm contracts and includes funded and unfunded portions. For further discussion of backlog, see Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of this Annual Report on Form 10-K. Summary backlog information for each business group follows:
DEFENSE BUSINESSFor defense programs, the funded backlog represents those items that have been authorized and appropriated by Congress and funded by the customer. The unfunded backlog represents orders for which funding has not been appropriated. To the extent the backlog has not been funded, there is no assurance that funding will be forthcoming; however, management believes it is highly likely.
AEROSPACEThe Aerospace funded backlog represents orders for which the company has definitive purchase contracts and deposits from a customer. The unfunded Aerospace backlog consists of options to purchase new aircraft and agreements to provide future aircraft maintenance and support services.
REGULATORY MATTERS
U.S. GOVERNMENT DEFENSE CONTRACTSGenerally, U.S. government contracts are subject to several procurement laws and regulations. In particular, contracts are governed by the Federal Acquisition Regulation (FAR), which lays out uniform policies and procedures for the acquisition of goods and services by the U.S. government, and agency-specific acquisition regulations that implement or supplement the FAR. For example, the Department of Defense implements the FAR through the Defense Federal Acquisition Regulation (DFAR). The FAR regulates all phases of the acquisition of products and services, including:
terminated, in whole or in part, at the government’s convenience or for default. If a contract is terminated for convenience of the government, a contractor is entitled to receive payments for its allowable costs and, in general, the proportionate share of fees or earnings for the work done. If a contract is terminated for default, the government generally pays for only the work it has accepted. These regulations also subject the company to financial audits and other reviews by the government of its costs, performance, accounting and general business practices relating to its contracts, which may result in adjustment of the company’s contract-related costs and fees. In addition, failure by the company to comply with procurement laws or regulations can result in civil, criminal or administrative proceedings involving fines, penalties, suspension of payments or suspension or disbarment from government contracting or subcontracting for a period of time.
INTERNATIONALThe company’s international sales are subject to U.S. and foreign government regulations and procurement policies and practices, including regulations relating to import-export control, investments, exchange controls and repatriation of earnings. International sales are also subject to varying currency, political and economic risks.
BUSINESS-JET AIRCRAFTThe Aerospace group is subject to FAA regulation in the United States and other similar aviation regulatory authorities throughout the world. For an aircraft to be manufactured and sold, the model must have received a type certificate from the appropriate aviation authority, and each individual aircraft must have received a certificate of airworthiness. Aviation authorities have the power to require changes to aircraft if deemed necessary for safety purposes. Maintenance facilities are also required to be licensed by aviation authorities.
ENVIRONMENTALThe company’s operations are subject to and affected by a variety of federal, state, local and foreign environmental laws and regulations relating to the discharge, treatment, storage, disposal, investigation and remediation of certain materials, substances and wastes. The company continually assesses its compliance status and management of environmental matters and believes that its operations are in substantial compliance with all applicable environmental laws and regulations. Operating and maintenance costs associated with environmental compliance and management of contaminated sites are a normal, recurring part of the company’s operations. These costs are not significant relative to total operating costs or cash flows, and often are allowable costs under the company’s contracts with the U.S. government. These costs have not been material in the past. Based on information currently available to the company and current U.S. government policies relating to allowable costs, the company does not expect continued compliance to have a material impact on its results of operations, financial condition or cash flows. A Potentially Responsible Party (PRP) has joint and several liability under existing U.S. environmental laws. Where the company has been designated a PRP by the Environmental Protection Agency or a state environmental agency, it is potentially liable to the government or third parties for the full cost of remediating contamination at the company’s facilities or former facilities or at third-party sites. In the unlikely event that the company is required to fully fund the remediation of a site, the statutory framework would allow the company to pursue rights to contribution from other PRPs. For additional information relating to the impact of environmental controls, see Note O to the Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K.
INTELLECTUAL PROPERTY
The company is a leader in the development of innovative products, manufacturing technologies and systems-integration practices. In addition to owning a large portfolio of proprietary intellectual property, the company licenses certain intellectual property rights of third parties, including the U.S. government. Additionally, the U.S. government licenses many of the company’s patents, pursuant to which the government may use or authorize others to use the inventions covered by the patents. Although these intellectual property rights are important to the operation of the company’s business, no existing patent, license or other intellectual property right is of such importance that its loss or termination would, in the opinion of management, have a material impact on the company’s business.
AVAILABLE INFORMATION
The company files with the Securities and Exchange Commission (SEC) and makes available several types of reports pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. These reports include an annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. Free copies of these reports are made available as soon as practicable on the company’s website (http://www.generaldynamics.com) or by calling investor relations at (703) 876-3000. These reports may also be obtained at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, DC 20549. Information on the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website (http://www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
ITEM 2. PROPERTIES
The company believes its main facilities are adequate for its present needs and, as supplemented by planned improvements and construction, expects them to remain adequate for the foreseeable future. A summary of floor space (square feet in millions) at the main facilities of the Information Systems and Technology, Combat Systems, Marine Systems and Aerospace business groups as of December 31, 2003, follows (a):
ITEM 3. LEGAL PROCEEDINGS
For information relating to legal proceedings, see Note O to the Consolidated Financial Statements contained in Part II, Item 8 of this Annual Report on Form 10-K.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the company’s security holders during the fourth quarter of the year ended December 31, 2003.
PART II
ITEM 5. MARKET FOR THE COMPANY’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The company’s common stock is listed on the New York Stock Exchange, Chicago Stock Exchange and Pacific Stock Exchange. The high and low sales prices of the company’s common stock and the cash dividends declared with respect to the company’s common stock for each quarterly period during the two most recent fiscal years are included in the Supplementary Data contained in Part II, Item 8 of this Annual Report on Form 10-K. The number of holders of the company’s common stock as of January 31, 2004, was approximately 117,800. The company made no repurchases of its common stock during the quarter ended December 31, 2003.
ITEM 6. SELECTED FINANCIAL DATA (UNAUDITED)
The following table presents summary selected historical financial data derived from the audited Consolidated Financial Statements and other company information for each of the five years presented. The following information should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the audited Consolidated Financial Statements and the Notes thereto.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(For an overview of the company’s business groups, including a discussion of products and services provided, see the Business discussion contained in Part I, Item 1 of this Annual Report on Form 10-K.)
MANAGEMENT OVERVIEW
General Dynamics designs, develops, manufactures and supports leading-edge technology products and services for mission-critical information systems and technologies; land and expeditionary combat vehicles, armaments and munitions; shipbuilding and marine systems; and business aviation. The company’s primary customers are the U.S. military, other government organizations, the armed forces of allied nations and a diverse base of corporate and industrial buyers. It operates through four primary business groups — Information Systems and Technology, Combat Systems, Marine Systems and Aerospace — and a smaller Resources group. The company has two primary business markets — defense and business aviation. The majority of the company’s revenues derive from contracts with the U.S. military. The Global War on Terrorism, Operation Iraqi Freedom and homeland defense concerns have focused the U.S. government’s efforts on ensuring that U.S. armed forces are equipped and trained to prevail in small- and large-scale conflicts around the world. At the same time, the president and the Department of Defense have indicated that they are committed to transforming the military into a more agile, responsive, lethal and survivable force for future engagements. These endeavors have driven steady funding increases for the Department of Defense since 2001. For fiscal year 2004, Congress appropriated $375 billion for the Department of Defense, a 21 percent increase in funding since 2001. This amount includes $140 billion for weapons and equipment procurement and research and development activities, an increase of 36 percent since 2001. These two funding areas deliver the majority of the company’s revenues, and their sustained increases demonstrate solid administration and congressional support for the U.S. military. Congress provided additional funding for Operation Iraqi Freedom, bringing the Department of Defense’s total funding to over $440 billion for fiscal year 2004. For fiscal year 2005, the president has requested that Congress appropriate $402 billion for the Department of Defense, a 7 percent increase over 2004, including $144 billion for procurement and research and development. While Department of Defense funding levels may change over time, levels of funding available for the company’s programs are expected to remain consistent for 2004 and 2005.
The global defense market is shaped largely by the demands of the U.S. military. Many foreign governments remain committed to funding weapons and equipment modernization in the pursuit of interoperability with U.S. and allied forces and flexible capabilities for peacekeeping and regional operations. The company continues to focus on the needs of these customers and expects growing international sales as it expands its market presence in Europe.
CONSOLIDATED OVERVIEW
Results of OperationsThe company’s net sales were $16.6 billion in 2003, up 20 percent over 2002. Acquisitions in Information Systems and Technology and Combat Systems and strong organic growth in the company’s defense businesses contributed to the sales growth, offset in part by reduced sales of new aircraft in Aerospace. The overall organic growth in 2003 was 8 percent, led by 20 percent organic growth in Information Systems and Technology. Growth from acquisitions in 2003 was 12 percent. In 2002, net sales increased by 15 percent over 2001 on strong volume in Information Systems and Technology and Combat Systems, as well as contributions from acquired businesses. About half of the sales growth in 2002 was organic. Net earnings grew more than 9 percent from 2002, to just over $1 billion in 2003. This increase resulted from both organic growth and acquisitions in Information Systems and Technology and Combat Systems, but was offset partially by decreased earnings in Marine Systems and Aerospace. The downward pressure on 2003 earnings from Marine Systems was driven by performance problems on commercial shipbuilding contracts. Aerospace 2003 earnings were lower because of reduced sales of new aircraft and market pricing pressures, particularly in the first half of the year; however, management is cautiously optimistic that the business-aviation market has stabilized. For 2002, the company’s net earnings were essentially flat compared with 2001 because of an after-tax charge of $134, reported as discontinued operations, that was associated with the company’s exit from its undersea fiber-optic cable-laying business. The company generated significant cash flow from operating activities in 2003 through strong operating results and diligent management of working capital, including sharply reduced levels of pre-owned aircraft inventory. Net cash provided by operating activities was $1.7 billion in 2003 compared with $1.1 billion in 2002 and 2001. The company used its cash to pay down debt, as reflected in an increase in net debt of only $2.1 billion during the year, despite making acquisitions in excess of $3 billion. The company also used the funds to repurchase its common shares, pay dividends and fund capital expenditures. In 2002 and 2001, cash from operating activities approximated net income. General and administrative (G&A) expenses as a percentage of sales have remained consistent year over year at around 6.5 percent. G&A was $1.1 billion in 2003, $903 in 2002 and $808 in 2001. Income from non-operating items was $3 in 2003 compared with $47 in 2002, which included a $36 gain from the sale of some assets of the Space Propulsion operation within Combat Systems. In 2001, expense
Backlog
The company’s total backlog increased 42 percent over 2002 to $41.1 billion at year-end 2003. This growth resulted from substantial new order activity in all business groups and acquisitions in Information Systems and Technology and Combat Systems. New orders received during 2003 totaled $25 billion, including an $8.4 billion submarine order in the Marine Systems group. The company’s funded backlog grew 18 percent over 2002 to $25.3 billion at the end of 2003. The company’s defense businesses contributed $34.3 billion to the 2003 year-end total backlog, an increase of 57 percent over 2002. This portion of the total backlog represents the estimated remaining sales value of work to be performed under firm contracts. The funded portion of this backlog increased to $21 billion in 2003 and includes items that have been authorized and appropriated by Congress and funded by the customer. The unfunded backlog represents firm orders for which funding has not been appropriated. The backlog does not include work awarded under indefinite delivery, indefinite quantity (IDIQ) contracts. The total potential value of these contracts was approximately $6.7 billion as of December 31, 2003, up from $3 billion at the end of 2002, and may be realized over the next 10 years. The Aerospace group’s total backlog of $6.5 billion remained steady in 2003 despite adverse economic conditions in the business-jet market in late 2002 and the first half of 2003. The Aerospace funded backlog was $4.1 billion at the end of 2003 and includes orders for which the company has definitive purchase contracts and deposits from the customer. The unfunded backlog, which consists of options to purchase new aircraft and agreements to provide future aircraft maintenance and support services, was $2.4 billion at year-end 2003, up slightly from 2002. The Resources group’s backlog was $220 as of year-end 2003, of which $163 was funded.
REVIEW OF OPERATING SEGMENTS
INFORMATION SYSTEMS AND TECHNOLOGY
Results of Operations and Outlook
The Information Systems and Technology group’s backlog increased $2.4 billion in 2003 to $7.7 billion at year end, from both acquisitions and new order activity. Over 80 percent of the group’s backlog at year end was funded. In contrast with the company’s other defense businesses, Information Systems and Technology’s backlog consists of a large number of relatively small dollar-value contracts and programs. These include programs that support the U.S. government’s military transformation, homeland security initiatives and overseas programs that underscore the growing international market for the company’s products and services. The group’s backlog does not include approximately $6.5 billion of potential contract value awarded under IDIQ contracts. A significant portion of this IDIQ value represents contracts for which the company has been designated as the sole-source supplier over several years to design, develop, produce and integrate complex products and systems for the military or other government agencies. Management believes that 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. In 2003, the company received two significant awards that extend two of the group’s longest-running programs. The Army awarded the company the Common Hardware/Software III (CHS-3) contract to provide continually updated commercial and ruggedized computers, network hardware equipment, power subsystems, peripheral devices and commercial software to the Army, Marine Corps, Air Force and other federal agencies worldwide. This IDIQ contract, which has a potential value of $2 billion over its 10-year life, is a follow-on to the company’s CHS-2 contract, now entering its tenth year. In addition, the Air Force selected the company for an IDIQ contract, called Intelligence Information, Command-and-Control Equipment and Enhancements (ICE2), to support and maintain critical intelligence and command-and-control systems and networks for U.S. defense and intelligence operations worldwide. The contract, which extends a program that
COMBAT SYSTEMS
The Combat Systems group’s total backlog rose 71 percent in 2003 to $8.5 billion at year end because of acquisitions and new order activity, including several significant contract awards. The group’s funded backlog also grew significantly, from $4.2 billion in 2002 to $6 billion at the end of 2003. The group’s backlog consists primarily of long-term production contracts with scheduled deliveries through 2012. During 2003, Combat Systems won several contracts to partner with the U.S. military as it transforms its forces for the future. The company received an order from the Army for the third of six brigades of Stryker wheeled combat vehicles, a key component of the Army’s transformation to a lighter, more mobile force. The order, for 267 vehicles, is valued at $384 and is scheduled for delivery in 2004. The year-end backlog included $566 for the production of Stryker vehicles. Congress appropriated funding in 2004 for the fourth brigade, and the 2005 budget request includes funding for the fifth brigade. The first brigade of Stryker vehicles is deployed in Operation Iraqi Freedom. With the acquisition of GM Defense, the company has consolidated its lead role on the $4 billion Stryker program, which calls for a total of 2,096 vehicles for six planned brigades. The company believes there is significant potential for international sales of these vehicles. In addition, the group and its teaming partner were selected to develop and demonstrate portions of the Army’s FCS program. The contracts awarded to the Combat Systems group in 2003 have a value of $2.2 billion and include engineering development and demonstration of a family of eight manned ground vehicles, as well as the development of the autonomous navigation systems for unmanned and manned ground vehicles. These ground vehicles are intended to be the new generation of Army combat vehicles. The Army also awarded Combat Systems the lead technology integration contract for the second phase of its Future Force Warrior (FFW) advanced technology demonstration program. The $100 award is for completion of detailed designs of the FFW network-centric soldier system, part of the Army’s plan to create a highly networked, lethal, survivable soldier of the future. The system development and demonstration phase of this program has a potential value of $1 to $3 billion over a 10-year period. The Combat Systems backlog also included approximately $380 for the continued design and development of the Marine Corps’ EFV program. Seven out of nine new infantry carrier prototypes, as well as a command-and-control prototype, have been completed as of year-end 2003. Initial production of more than 1,000 vehicles is scheduled to begin in 2006. The company received additional funding to upgrade M1A2 Abrams battle tanks to the M1A2 System Enhancement Package (SEP) configuration. Through this program, the company retrofits M1A2 tanks with improved electronics, command-and-control capabilities and armor enhancements that improve the tank’s effectiveness. The administration’s 2005 budget request includes funding for more M1A2 SEP upgrades. In addition, the company was awarded a contract modification in 2003 to provide 125 M1A1 hardware kits for the Egyptian tank co-production program, bringing the total program, which began in 1992, to 880 M1A1 tank kits. The Combat Systems group’s Leopard program is a long-term battle tank manufacturing contract for the Spanish army under license from a German company. The year-end backlog included $1.4 billion for the production of 232 Leopard tanks, with deliveries scheduled through 2008. The company also produces Pizarro Advanced Infantry Fighting Vehicles for the Spanish army. The Spanish government awarded the company a contract valued at $640 for the second phase of the Pizarro program, bringing the total program value to almost $900, with deliveries of 212 vehicles scheduled through 2012. Combat Systems’ backlog at year-end 2003 included approximately $1.2 billion in armament, munitions and composite structures programs, such as reactive armor for the Bradley fighting vehicle and various trainable gun-mount systems. The ammunition programs include a $200 order from the Army in 2003 for rockets, motors and warheads for the Hydra-70 (70mm) rocket system, which raised the program value to date to over $800 and extended deliveries through 2006. The Army also awarded the company a contract to add a precision guidance system to the 70mm rocket family as part of the development of the next-generation Advanced Precision Kill Weapon System (APKWS). The composite structures programs include work on numerous aerospace platforms, including the F-16, F-18, F-22, C-17, Joint Strike Fighter and unmanned aerial vehicles such as the Global Hawk and the Predator.
MARINE SYSTEMS
The Marine Systems group’s backlog grew remarkably in 2003 as a result of several significant contract awards. At the end of 2003, the group’s backlog reached an all-time high of $18.2 billion, a 56 percent increase over 2002. The backlog consists of numerous long-term submarine and ship construction programs, as well as repair and engineering contracts. The Navy’s shipbuilding plan will continue to have a significant influence on Marine Systems’ backlog. In 2003, the Navy awarded the company an $8.7 billion contract for the construction of the next six Virginia-class submarines, the largest submarine order in U.S. history. The contract authorizes construction of one ship per year from 2003 through 2008. In January 2004, the five ships planned for construction from 2004 through 2008 became part of a multiyear agreement, saving the customer approximately $300 and shifting $1.5 billion from unfunded to funded backlog. In 1998, the Navy had awarded the company a contract to build the first four Virginia-class submarines of this potential 30-ship program. The Marine Systems group’s backlog at year end included $1.7 billion associated with these first four submarines, with one submarine scheduled to be delivered each year from 2004 through 2007. The lead ship in the class, theVirginia, was christened in August 2003. The company is the prime contractor on this program, and construction is shared equally with its teaming partner.
AEROSPACE
Summary of Aircraft Statistical InformationSales contracts for new aircraft usually have two major milestones: the manufacture of the green aircraft and the aircraft’s completion, which includes exterior painting and installation of customer-selected interiors and optional avionics. The company records revenues when green aircraft are delivered to and accepted by the customer, and when the customer accepts final delivery of the fully outfitted aircraft. The following table summarizes key unit data for the Aerospace group’s orders and backlog:
The Aerospace group’s backlog remained steady in 2003 despite the difficult market conditions, ending the year at $6.5 billion, of which $4.1 billion was funded. The backlog includes aircraft deliveries scheduled through 2010. Approximately $2.1 billion, or 51 percent, of the group’s funded backlog is with NetJets Inc. (NetJets), a unit of Berkshire Hathaway and the leader in the fractional aircraft market, representing firm contracts for 114 aircraft. The unfunded backlog includes $1.4 billion for 100 aircraft options from NetJets, constituting 90 percent of the options in backlog. NetJets also represents almost 70 percent of the maintenance and support services in unfunded backlog. Deliveries of aircraft to NetJets are scheduled from 2004 through 2010 and represent as little as 4 percent and as much as 17 percent of projected new aircraft sales in those years. The group’s remaining $2 billion of funded backlog at year-end 2003 consists of contracts with a broad range of customers from a variety of industries and approximately $440 of contracts with government customers. The company continues to pursue opportunities to provide special mission aircraft to military customers around the world. In 2003, the company was awarded a contract to provide four Gulfstream G550 aircraft to the Israeli Ministry of Defense. The contract has an option for two additional G550 aircraft, for a total potential value of approximately $470. In addition, the company’s Gulfstream G450 aircraft was designated the platform of choice by one of the two competitors in a pending U.S. military procurement for special mission ISR applications.
RESOURCES
The company’s Resources group principally consists of two businesses: a coal mining company and an aggregates company that supplies the construction industry.
Results of Operations
Net sales and earnings in 2002 improved over 2001 because of increased volume and improved cost performance in the aggregates business. In addition, as noted above, earnings increased as a result of the reversal of contingency reserves.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
In the mid-1990s, the company embarked on a strategy of disciplined capital deployment through strategic and tactical acquisitions designed to grow the company beyond its core platform businesses. These acquisitions incorporated new products and technologies and expanded the company’s customer base. Since 1995, the company has acquired more than 30 businesses at a total cost of approximately $13.2 billion. This has resulted in a larger, more diversified company while preserving a strong balance sheet and sustained financial flexibility. In terms of overall capital deployment for 2003, the company consummated over $3 billion of acquisitions, repurchased approximately 4.7 million of its outstanding common shares at an average price of $64 per share and continued its trend of consecutive annual dividend increases. Meanwhile, and in spite of the $3 billion in acquisitions, net debt (total debt less cash and equivalents) increased only $2.1 billion — to $3.2 billion at December 31, 2003. At the same time, the company converted a significant portion of its commercial paper to fixed-rate debt to take advantage of attractive borrowing rates available to the company. The company ended the year with a cash balance of $860, total debt of $4 billion and a debt-to-capital ratio of 41 percent. Cash generation continues to be one of management’s key areas of focus, and 2003 was a particularly strong year in this regard. Free cash flow from operations for the year totaled $1.5 billion, compared with $861 in 2002 and $745 in 2001. Management defines free cash flow from operations as cash flow from operating activities 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 such purposes as repaying maturing debt, funding business acquisitions and paying dividends. The following table reconciles the free cash flow from operations with the cash flow from operating activities, as classified on the Consolidated Statement of Cash Flows:
that the company has adequate funds on hand and sufficient borrowing capacity to execute its financial and operating strategy. Going forward in 2004, management anticipates focusing on operations and the integration of recently acquired businesses. The following is a discussion of the company’s major operating, investing and financing activities for each of the three years in the period ended December 31, 2003, as classified on the Consolidated Statement of Cash Flows.
Operating ActivitiesNet cash provided by operating activities was $1.7 billion in 2003, compared with $1.1 billion in both 2002 and 2001. The increase in cash flows in 2003 was due to substantial reductions in both new and pre-owned aircraft inventories in the Aerospace group and an influx of customer advances and deposits near the end of the year. In 2002 and 2001, cash provided by operating activities approximated net income. Termination of A-12 Program. As discussed further in Note O to the Consolidated Financial Statements, litigation on the A-12 program termination has been ongoing since 1991. If, contrary to the company’s expectations, the default termination is ultimately 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 $1.1 billion at December 31, 2003. In this outcome, the government contends the company’s liability would be approximately $1.2 billion pretax, or $700 after-tax. The company believes that it has sufficient resources to pay such an obligation, if required, while still retaining ample liquidity.
Investing ActivitiesCash used in investing activities was $3.2 billion in 2003, $400 in 2002 and $1.7 billion in 2001. The primary uses of cash in investing activities were business acquisitions and capital expenditures, offset slightly by cash received from the sale of assets. Business Acquisitions. On August 11, 2003, the company completed its acquisition of Veridian Corporation, headquartered in Arlington, Virginia, for approximately $1.5 billion in cash. On March 1, 2003, the company acquired GM Defense of London, Ontario, a business unit of General Motors Corporation, for approximately $1.1 billion in cash. On June 14, 2002, the company acquired the outstanding stock of Advanced Technical Products, Inc., for $214 in cash, plus the assumption of $43 in outstanding debt, which was repaid at the time of the acquisition. On September 28, 2001, the company acquired IISG from Motorola, Inc., for $825 in cash. On June 5, 2001, the company acquired substantially all of the assets of Galaxy Aerospace Company LP, for $330 in cash, after a purchase price adjustment received during the first quarter of 2002. The company may be required to make additional payments to the selling parties, up to a maximum of approximately $300 through 2006, contingent on the achievement of specific revenue targets. On January 26, 2001, the company acquired Primex Technologies, Inc., for $334 in cash plus the assumption of $204 in outstanding debt, $149 of which was repaid at the time of the acquisition. The company completed several other business acquisitions in the Information Systems and Technology, Combat Systems and Aerospace groups during the last three years at a total cost of $515. The company financed these acquisitions by issuing commercial paper. The company refinanced a significant portion of this debt during 2003, as discussed in Financing Activities. Capital Expenditures. Capital expenditures in 2003 were $224, down approximately 15 percent from $264 in 2002. In 2002, capital expenditures decreased approximately 25 percent from the $356 spent in 2001 as a result of the completion of a facility modernization project at the company’s Bath Iron Works shipyard in 2001. The company expects capital expenditures in 2004 to remain consistent with 2003. The company had no material commitments for capital expenditures as of December 31, 2003. Sale of Assets. On October 2, 2002, the company sold certain assets of its Space Propulsion operation for $90. The remainder of the Space Propulsion operation is included in the Combat Systems group. On February 15, 2001, the Aerospace group sold its engine overhaul business for $55. The company received approximately $60 in cash during the three-year period ended December 31, 2003, from the sale of real estate in southern California.
Financing ActivitiesIn 2003, cash provided by financing activities was $2 billion as a result of the issuance of fixed-rate notes, offset in part by repayment of outstanding debt, repurchases of common stock and payment of dividends. In 2002, cash used by financing activities was $836, and cash provided was $908 in 2001. Debt Proceeds, Net. On April 3, 2003, the company filed a Form S-3 Registration Statement (the Registration Statement) with the Securities and Exchange Commission to register $3 billion of debt securities under the Securities Act of 1933, as amended (the Securities Act). On May 15, 2003, the company issued $2 billion of medium-term fixed-rate debt pursuant to the Registration Statement. On August 14, 2003, the company extended the debt registered to $3.1 billion and issued an additional $1.1 billion of medium-term fixed-rate debt pursuant to the Registration Statement. The proceeds were used to repay a substantial portion of the company’s outstanding commercial paper. This had the effect of fixing interest rates on debt that previously carried variable rates.
ADDITIONAL FINANCIAL INFORMATION
Off-Balance Sheet ArrangementsAs of December 31, 2003, the company had no material off-balance sheet arrangements, other than operating leases. This includes guarantees; retained or contingent interests in assets transferred to unconsolidated entities; derivative instruments indexed to the company’s stock and classified in shareholders’ equity on the Consolidated Balance Sheet; and variable interests in entities that provide financing, liquidity, market risk or credit risk support to the company or engage in leasing, hedging or research and development services with the company.
Contractual ObligationsThe following table presents information about the company’s contractual obligations as of December 31, 2003:
Commercial CommitmentsThe following table presents information about the company’s commercial commitments as of December 31, 2003:
Application of Critical Accounting PoliciesManagement’s Discussion and Analysis of the company’s Financial Condition and Results of Operations is based on the company’s Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (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 postretirement benefits, workers’ compensation, warranty obligations, pre-owned aircraft inventory, 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. Management believes the following policies are critical and require the use of significant business judgment in their application: Revenue Recognition — Government Contracts. The company accounts for sales and earnings under long-term defense contracts and programs using the percentage-of-completion method of accounting. The company follows the guidelines of American Institute of Certified Public Accountants Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts,” except that revisions of estimated profits on contracts are included in earnings under the reallocation method, in accordance with Accounting Principles Board Opinion No. 20, “Accounting Changes,” rather than the cumulative catch-up method. Under the reallocation method, the impact of revisions in estimates is recognized prospectively over the remaining life of the contract, while under the cumulative catch-up method such impact would be recognized immediately. If a revised estimate of contract profitability reveals an anticipated loss on the contract, the company recognizes the loss in the period it is identified. The company estimates profit as the difference between total estimated revenue and total estimated cost of a contract and recognizes that profit evenly over the remaining life of the contract based on either input (e.g., costs incurred) or output (e.g., units delivered) measures, as appropriate to the circumstances. The percentage-of-completion method of accounting involves the use of various estimating techniques to project costs at completion, and in some cases includes estimates of recoveries asserted against the customer for changes in specifications. These estimates involve various assumptions and projections relative to the outcome of future events over a period of several years, including future labor productivity and availability, the nature and complexity of the work to be performed, availability of materials, the impact of delayed performance, availability and timing of funding from the customer, and the timing of product deliveries. These estimates require the use of judgment. A significant change in one or more of these estimates could affect the profitability of one or more of the company’s contracts. The company reviews its contract estimates periodically to assess revisions in contract values and estimated costs at completion and reflects changes in estimates in the current and future periods under the reallocation method. Business Aircraft. The company accounts for contracts for aircraft certified by the FAA in accordance with Statement of Position 81-1. These contracts usually provide for two major milestones: the manufacture of the “green” aircraft (i.e., before exterior painting and installation of customer-selected interiors and optional avionics) and its completion. The company records revenues at two points: when green aircraft are delivered to and accepted by the customer and when the customer accepts final delivery of the fully outfitted aircraft. The company does not recognize revenue at green delivery unless (1) a contract has been executed with the customer and (2) the customer can be expected to satisfy its obligations under the contract, as evidenced by the receipt of deposits from the customer.
Management believes that its judgment is applied consistently and produces financial information that fairly depicts the results of operations for all periods presented.
New Accounting StandardsThe Financial Accounting Standards Board (FASB) issued FASB Interpretation No. (FIN) 46, “Consolidation of Variable Interest Entities,” in January 2003. The FASB revised FIN 46 in December 2003 to clarify certain provisions and amend the effective date. FIN 46 provides guidance on the consolidation of certain entities. The interpretation requires a variable interest entity to be consolidated if the equity interest at risk is not sufficient to permit that entity to finance its activities without support from other parties or if the equity investors lack certain specified characteristics. FIN 46 is effective December 31, 2003, for special-purpose entities created before February 1, 2003, and is effective in the first quarter of 2004 for all other variable interest entities. The company does not expect the adoption of FIN 46 to have a material effect on its results of operations, financial condition or cash flows.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The company is exposed to market risk, primarily related to interest rates and foreign currency exchange rates. Financial instruments subject to interest rate risk include fixed-rate and variable-rate long-term debt obligations, variable-rate commercial paper and short-term investments. As of December 31, 2003, the company had no short-term investments. Fixed-rate debt obligations issued by the company are generally not putable until maturity and are not actively traded by the company in the market. Therefore, exposure to interest rate risk is not believed to be material for the company’s fixed-rate debt. A hypothetical 100 basis-point increase in market rates of interest applicable to the company’s commercial paper balances and floating-rate notes would not have a material effect on its results of operations, financial condition or cash flows. The company may enter into interest rate swap agreements to manage its exposure to interest rate fluctuations. At December 31, 2003, no interest rate swap agreements were in effect. The company also is subject to foreign currency exchange rate risk relating to receipts from customers, payments to suppliers and certain inter-company transactions in foreign currencies. The company principally uses foreign currency forward contracts from time to time to hedge the price risk associated with firmly committed and forecasted foreign-denominated payments, receipts and inter-company transactions related to its ongoing business and operational financing activities. Foreign currency contracts are sensitive to changes in foreign currency exchange rates. At December 31, 2003, a 10 percent unfavorable exchange rate movement in the company’s portfolio of foreign currency forward contracts would have resulted in an incremental realized loss of $28 (pretax) and an incremental unrealized loss of $22 million (pretax). Consistent with the use of these contracts to neutralize the effect of exchange rate fluctuations, such realized and unrealized losses would be offset by corresponding gains, respectively, in the remeasurement of the underlying transactions being hedged. When taken together, these forward contracts and the offsetting underlying commitments do not create material market risk.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Consolidated Statement of Earnings
Consolidated Balance Sheet
The accompanying Notes to Consolidated Financial Statements are an integral part of this statement.
Consolidated Statement of Cash Flows
Consolidated Statement of Shareholders’ Equity
(Dollars in millions, except per share amounts or unless otherwise noted)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIESOrganization. The company’s businesses include mission-critical information systems and technologies; land and expeditionary combat vehicles, armaments and munitions; shipbuilding and marine systems; and business aviation. The company also owns a coal mining operation and an aggregates operation. The company’s primary customers are the U.S. military, other government organizations, the armed forces of allied nations and a diverse base of corporate and industrial buyers. Basis of Consolidation and Use of Estimates. The Consolidated Financial Statements include the accounts of all wholly owned and majority-owned subsidiaries. Inter-company balances and transactions have been eliminated in consolidation. The financial statements for all periods presented have been restated to reflect the results of operations of the company’s undersea fiber-optic cable-laying business in discontinued operations, as discussed in Note C. Accounting principles generally accepted in the United States of America (GAAP) require 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. Actual results could differ from these estimates. Revenue Recognition. The company accounts for sales and earnings under long-term defense contracts and programs using the percentage-of-completion method of accounting in accordance with AICPA Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” The company applies earnings rates to all contract costs, including general and administrative (G&A) expenses, to determine sales and operating earnings. The company reviews earnings rates periodically to assess revisions in contract values and estimated costs at completion. Based on these assessments, any changes in earnings rates are made prospectively. The company charges any anticipated losses on contracts and programs to earnings when identified. Such losses encompass all costs allocable to the contracts, including G&A expenses on government contracts. The company recognizes revenue arising from a claims process either as income or as an offset against a potential loss only when the claim can be reliably estimated and its realization is probable. The company accounts for contracts for aircraft certified by the Federal Aviation Administration in accordance with Statement of Position 81-1. These contracts usually provide for two major milestones: the manufacture of the “green” aircraft and its completion. Completion includes exterior painting and installation of customer-selected interiors and optional avionics. The company records revenue at two points: when green aircraft are delivered to and accepted by the customer and when the customer accepts final delivery of the fully outfitted aircraft. The company recognizes sales of all other aircraft products and services when the product is delivered or the service is performed. General and Administrative Expenses. G&A expenses were $1.1 billion in 2003, $903 in 2002 and $808 in 2001, and are included in operating costs and expenses on the Consolidated Statement of Earnings. Interest Expense, Net. Interest expense was $108 in 2003, $58 in 2002 and $68 in 2001. Interest payments were $79 in 2003, $55 in 2002 and $70 in 2001. Other Income (Expense), Net. Net other income in 2002 included a $36 pretax gain on the sale of some assets of the company’s Space Propulsion operations that were sold during the fourth quarter of 2002. Cash and Equivalents and Investments in Debt and Equity Securities. The company classifies its securities in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” The company considers securities with a maturity of three months or less to be cash equivalents. The company adjusts all investments in debt and equity securities to fair value. The company recognizes market adjustments in the statement of earnings for trading securities and as a component of accumulated other comprehensive income for available-for-sale securities. The company had available-for-sale investments of $43 at December 31, 2003, and $50 at December 31, 2002. The company had no investments classified as trading securities at the end of either period. Accounts Receivable and Contracts in Process. Accounts receivable represent only amounts billed and currently due from customers. Recoverable costs and accrued profit related to long-term defense contracts and programs on which revenue has been recognized, but billings have not yet been presented to the customer (unbilled receivables) are included in contracts in process. Inventories.Work-in-process inventories represent aircraft components and are stated at the lower of cost (based on estimated average unit cost of the number of units in a production lot, or specific identification) or market. Raw materials are stated at the lower of cost (first-in, first-out method) or market. The company records pre-owned aircraft acquired in connection with the sale of new aircraft at the lower of the trade-in value (determined at the time of trade and based on estimated fair value) or estimated net realizable value.
Property, Plant and Equipment, Net. Property, plant and equipment are carried at historical cost, net of accumulated depreciation, depletion and amortization. Most of the company’s assets are depreciated using the straight-line method, with the remainder using accelerated methods. Buildings and improvements are depreciated over periods up to 50 years. Machinery and equipment are depreciated over periods up to 39 years. Depletion of mineral reserves is computed using the units-of-production method. Impairment of Long-Lived Assets. The company reviews long-lived assets, including intangible assets subject to amortization, for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The company assesses the recoverability of the cost of the asset based on a review of projected undiscounted cash flows. In the event an impairment loss is identified, it is recognized based on the amount by which the carrying value exceeds the estimated fair value of the long-lived asset. If an asset is held for sale, the company reviews its estimated fair value less cost to sell. Environmental Liabilities. The company accrues environmental costs when it is probable that a liability has been incurred and the amount can be reasonably estimated. The company recorded cleanup and other environmental exit costs related to sold businesses at the time of disposal. Recorded liabilities have not been discounted. To the extent the U.S. government has specifically agreed to pay the ongoing maintenance and monitoring costs at sites currently used in the conduct of the company’s government contracting business, the company treats these costs as contract costs and recognizes the costs as paid. Fair Value of Financial Instruments. The company’s financial instruments include cash and equivalents, accounts receivable, accounts payable, short- and long-term debt and derivative financial instruments. The company estimates the fair value of these financial instruments as follows:
The differences between the estimated fair value and carrying value of the company’s financial instruments were not material as of December 31, 2003 and 2002. Stock-Based Compensation. The company accounts for its incentive compensation plans under the recognition and measurement principles of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. The company measures compensation expense for stock options as the excess, if any, of the quoted market price of the company’s stock at the measurement date over the exercise price. The company records stock awards at fair value at the date of the award. See Note P for a description of the company’s equity compensation plans. Had compensation expense for stock options been determined based on the fair value at the grant dates for awards under the company’s equity compensation plans, the company’s net earnings and net earnings per share would have been reduced to the pro forma amounts indicated as follows:
The compensation cost calculated under the fair value approach shown above is recognized over the vesting period of the stock options. Fair value of options is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions for 2003, 2002 and 2001, respectively:
Translation of Foreign Currencies. The functional currencies for the company’s international operations are the respective local currencies. The company translates foreign currency balance sheets at the end-of-period exchange rates and earnings statements at the average exchange rates for each period. The company includes the resulting foreign currency translation adjustments in the calculation of accumulated other comprehensive income, which is included in shareholders’ equity on the Consolidated Balance Sheet. Classification.Consistent with defense industry practice, the company classifies assets and liabilities related to long-term production contracts as current, even though a portion of these amounts is not expected to be realized within one year. In addition, certain prior-year amounts have been reclassified to conform to the current-year presentation.
B. ACQUISITIONS, INTANGIBLE ASSETS AND GOODWILL, NETIn 2003, the company completed the following acquisitions for a total cost of approximately $3 billion, which was paid in cash:
Information Systems and Technology
Combat Systems
In 2002, the company acquired the following businesses for a total cost of $275, which was paid in cash:
In 2001, the company acquired the following businesses for a total cost of approximately $1.4 billion, which was paid in cash:
Aerospace
The operating results of these businesses have been included with those of the company from their respective closing dates. The purchase prices of these businesses have been allocated to the estimated fair value of net tangible and intangible assets acquired, with any excess recorded as goodwill. Certain of the estimates related to the Veridian, IMCO, DSR and Steyr acquisitions are still preliminary at December 31, 2003. The company is awaiting the completion of the identification and valuation of intangible assets acquired. The company expects these analyses to be completed during the first quarter of 2004. Intangible assets consisted of the following:
The company amortizes contract and program intangible assets on a straight-line basis over periods ranging from 5 to 40 years. Other intangible assets consist primarily of aircraft product design, customer lists, software and licenses, which are amortized over periods ranging from 5 to 15 years. Amortization expense was $70 in 2003, $34 in 2002 and $100 (including $70 of goodwill amortization) in 2001. The company expects to record annual amortization expense over the next five years as follows:
The company adopted SFAS 142, “Goodwill and Other Intangible Assets,” on January 1, 2002. The provisions of SFAS 142 eliminate amortization of goodwill and identifiable intangible assets with indefinite lives. Intangible assets with a finite life continue to be amortized over their useful life. The standard also requires an impairment assessment of goodwill and indefinite-lived intangible assets at least annually by applying a fair-value-based test. The company completed the required annual impairment test during the fourth quarter of 2003 and did not identify any impairment. The following table presents comparative earnings data as if SFAS 142 had been adopted January 1, 2001:
The changes in the carrying amount of goodwill by business group for the year ended December 31, 2003, were as follows:
C. DISCONTINUED OPERATIONS
Assets and liabilities of discontinued operations are recorded in other current assets and other current liabilities, respectively, on the Consolidated Balance Sheet and consisted of the following:
D. EARNINGS PER SHAREBasic earnings per share for all periods presented is computed using net earnings for the respective periods 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 contingently issuable shares. Basic and diluted weighted average shares outstanding were as follows (in thousands):
E. INCOME TAXES
The net provision for income taxes for continuing operations is summarized as follows:
The reconciliation from the statutory federal income tax rate to the company’s effective income tax rate follows:
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and liabilities consisted of the following:
The current portion of the net deferred tax asset was $333 at December 31, 2003, and $194 at December 31, 2002, and is included in other current assets on the Consolidated Balance Sheet. As of December 31, 2003, the company had U.S. and foreign operating loss carryforwards of $43, the majority of which begin to expire in 2017. The company had foreign investment tax credit carryforwards of $16 that begin to expire in 2011, and U.S. capital loss carryforwards of $4 that begin to expire in 2009. The company provided a valuation allowance totaling $56 as of December 31, 2003, and $48 as of December 31, 2002, on certain of its deferred tax assets, the recovery of which is uncertain.
company’s consolidated federal income tax returns have been examined by the IRS through 1998. Based on the results of those examinations, the company reduced its liabilities for tax contingencies, recognizing a non-cash benefit of $49, or $.25 per share. The company settled various other outstanding state tax disputes during the year, resulting in a net non-cash benefit of $19, or $.10 per share.
F. CONTRACTS IN PROCESS
Contract costs include production costs and related overhead, such as G&A expenses, as well as contract recoveries for such matters as contract changes, negotiated settlements and claims for unanticipated contract costs, which totaled $21 as of December 31, 2003, and $29 as of December 31, 2002. The company records revenue associated with these matters as either income or as an offset against a potential loss only when recovery can be reliably estimated and realization is probable. Other contract costs represent amounts required to be recorded under GAAP that are not currently allocable to contracts, such as a portion of the company’s estimated workers’ compensation, other insurance-related assessments, retirement benefits and environmental expenses. These costs will become allocable to contracts when they are paid. The company expects to recover these costs through ongoing business, including both existing backlog and probable follow-on contracts. This business base includes numerous contracts for which the company is the sole source or one of two suppliers on long-term defense programs. If the level of 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.
G. INVENTORIES
H. PROPERTY, PLANT AND EQUIPMENT, NET
I. DEBT
On April 3, 2003, the company filed a Form S-3 Registration Statement (the Registration Statement) with the Securities and Exchange Commission to register $3 billion of debt securities under the Securities Act of 1933, as amended (the Securities Act). On May 15, 2003, the company issued $2 billion of fixed-rate notes pursuant to the Registration Statement, consisting of the following:
On August 14, 2003, the company extended the debt registered to $3.1 billion and issued an additional $1.1 billion of fixed-rate notes pursuant to the Registration Statement, consisting of the following:
The proceeds were used to repay a substantial portion of the company’s outstanding commercial paper.
$20 payable in December 2008. Interest is payable in June and December at the rate of 7.5 percent annually.
J. OTHER CURRENT LIABILITIES
K. OTHER LIABILITIES
L. SHAREHOLDERS’ EQUITY
M. FINANCE OPERATION
The company is scheduled to receive minimum lease payments of $24 in 2004 and $21 in 2005, 2006, 2007 and 2008.
N. FOREIGN EXCHANGE RISK MANAGEMENT
O. COMMITMENTS AND CONTINGENCIES
Litigation
evidence. A government petition for rehearing in the Court of Appeals was denied on August 27, 2003, and the case was again remanded to the Trial Court for further proceedings.
Environmental
Minimum Lease Payments
Other
As a government contractor, the company is from time to time subject to U.S. government investigations relating to its operations, including claims for fines, penalties and compensatory and treble damages. The company believes, based on current available information, that the outcome of such ongoing government disputes and investigations will not have a material effect on its results of operations, financial condition or cash flows.
P. EQUITY COMPENSATION PLANS
Under the Incentive Compensation Plan, awards may be granted to employees in cash, common stock, options to purchase common stock, restricted shares of common stock or any combination of these. Awards of stock options and restricted stock are intended to qualify as deductible, performance-based compensation under Section 162(m) of the Internal Revenue Code of 1986, as amended (the Code). Incentive Compensation Plan awards of cash and unrestricted stock are not designed to be deductible by the company under Section 162(m).
the restricted shares and to retain cash dividends paid thereon. Awards of restricted shares may be granted pursuant to a performance formula whereby the number of shares initially granted increases or decreases based on the increase or decrease in the price of the common stock over a performance period.
At December 31, 2003, in addition to the shares reserved for issuance on the exercise of options outstanding, 3,609,413 shares have been authorized for options and restricted stock that may be granted in the future. Information with respect to stock options follows:
Information with respect to stock options outstanding and exercisable at December 31, 2003, is as follows:
Q. RETIREMENT PLANS
The accumulated benefit obligation for all defined benefit pension plans was $5,821 at December 31, 2003, and $4,919 at December 31, 2002. The accumulated benefit obligation is the actuarial present value of benefits attributed to employee services rendered to date excluding assumptions about future compensation levels.
Net periodic pension and other postretirement benefit costs consisted of the following:
The following table presents the assumptions used to determine the company’s benefit obligations and net periodic pension and other postretirement benefit costs.
The company relies on historical long-term rates of return by asset class, the current long-term U.S. Treasury bond rate, and the current and expected asset allocation strategy to determine its expected long-term rate of return assumptions.
The company amortizes changes in prior service cost resulting from plan amendments on a straight-line basis over the average remaining service period of employees expected to receive benefits under the plan.
Other Postretirement Benefits. The company maintains plans providing postretirement health care coverage for many of its current and former employees and postretirement life insurance benefits for certain retirees. These benefits vary by employment status, age, service and salary level at retirement. The coverage provided and the extent to which the retirees share in the cost of the program vary throughout the company. Both health and life insurance benefits are provided only to those employees who retire directly from the service of the company and not to those who terminate service/seniority prior to eligibility for retirement.
R. BUSINESS GROUP INFORMATION
The following table presents revenues by geographic area (based on the location of the company’s customers):
S. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
The fixed-rate notes and the floating-rate notes described in Note I 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 as of December 31, 2003 and 2002, for the balance sheet, as well as the statements of earnings and cash flows for each of the three years in the period ended December 31, 2003.
CONDENSED CONSOLIDATING STATEMENT OF EARNINGS
CONDENSED CONSOLIDATING BALANCE SHEET
CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
STATEMENT OF FINANCIAL RESPONSIBILITY
To the Shareholders of General Dynamics Corporation:
The management of General Dynamics Corporation is responsible for the consolidated financial statements and all related financial information contained in this report. The financial statements, which include amounts based on estimates and judgments, have been prepared in accordance with accounting principles generally accepted in the United States of America applied on a consistent basis.
INDEPENDENT AUDITORS’ REPORT
To General Dynamics Corporation:
We have audited the accompanying Consolidated Balance Sheets of General Dynamics Corporation (a Delaware corporation) and subsidiaries as of December 31, 2003 and 2002, and the related Consolidated Statements of Earnings, Shareholders’ Equity and Cash Flows for each of the years in the three-year period ended December 31, 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
McLean, VirginiaJanuary 20, 2004
SUPPLEMENTARY DATA (Unaudited)
Quarterly data is based on a 13-week period.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
ITEM 9A. CONTROLS AND PROCEDURESThe 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 Rules 13a-15(e) under the Securities Exchange Act of 1934, as amended) as of December 31, 2003. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of December 31, 2003, the company’s disclosure controls and procedures were effective. There were no significant changes in the company’s internal controls over financial reporting that occurred during the quarter ended December 31, 2003, that have materially affected, or are reasonably likely to materially affect, the company’s internal controls over financial reporting.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Executive Officers of the RegistrantAll executive officers of the company are elected annually. No executive officer of the company was selected pursuant to any arrangement or understanding between the officer and any other person. The name, age, offices and positions held for the last five years of the company’s executive officers as of March 5, 2004, were as follows:
Code of EthicsThe company has adopted a Code of Ethics for Financial Professionals that applies to the company’s chief executive officer, chief financial officer, controller and any person performing similar functions for the company. The company has also adopted a Code of Conduct for members of the Board of Directors and a handbook of Standards of Business Ethics and Conduct that is applicable to all employees of the company. Copies of the foregoing, as well as the company’s Corporate Governance Guidelines and charters for each of the standing committees of the Board of Directors (including the Audit, Nominating and Corporate Governance, and Compensation Committees) are available on the company’s website (http://www.generaldynamics.com), and are also available in print to any shareholder upon request by calling investor relations at (703) 876-3000. The company intends to disclose on its website any amendments to, or waivers from, its Code of Ethics, Code of Conduct or Standards of Business Ethics and Conduct on behalf of any financial professional, director or executive officer of the company. The information contained on or connected to the company’s website is not incorporated by reference into this Annual Report on Form 10-K and should not be considered part of this or any other report filed with the SEC.
ITEM 11. EXECUTIVE COMPENSATION
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
SIGNATURES
March 5, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below on March 5, 2004, by the following persons on behalf of the Registrant and in the capacities indicated, including a majority of the directors.
*By David A. Savner pursuant to a Power of Attorney executed by the directors listed above, which Power of Attorney has been filed as an exhibit hereto and incorporated herein by reference thereto.
INDEX TO EXHIBITS — GENERAL DYNAMICS CORPORATIONCOMMISSION FILE NO. 1-3671
Exhibits listed below, which have been filed with the Commission pursuant to the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, and which were filed as noted below, are hereby incorporated by reference and made a part of this report with the same effect as if filed herewith.