10-Q 1 gd-2014092810q.htm 10-Q

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 28, 2014
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 1-3671
GENERAL DYNAMICS CORPORATION
(Exact name of registrant as specified in its charter)

Delaware |  | 13-1673581
State or other jurisdiction of incorporation or organization |  | I.R.S. employer identification no.
2941 Fairview Park Drive, Suite 100 Falls Church, Virginia |  | 22042-4513
Address of principal executive offices |  | Zip code

(703) 876-3000
Registrant’s telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes ü No ___
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ü No ___
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ü Accelerated Filer __ Non-Accelerated Filer __ Smaller Reporting Company ___
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No ü
331,389,741 shares of the registrant’s common stock, $1 par value per share, were outstanding on September 28, 2014.

1

INDEX

PART I - | FINANCIAL INFORMATION | PAGE
Item 1 - | Unaudited Consolidated Financial Statements |
| Consolidated Statements of Earnings (Three Months) | 3
| Consolidated Statements of Earnings (Nine Months) | 4
| Consolidated Statements of Comprehensive Income (Three and Nine Months) | 5
| Consolidated Balance Sheets | 6
| Consolidated Statements of Cash Flows | 7
| Consolidated Statements of Shareholders' Equity | 8
| Notes to Unaudited Consolidated Financial Statements | 9
Item 2 - | Management’s Discussion and Analysis of Financial Condition and Results of Operations | 27
Item 3 - | Quantitative and Qualitative Disclosures About Market Risk | 42
Item 4 - | Controls and Procedures | 42
| FORWARD-LOOKING STATEMENTS | 42
PART II - | OTHER INFORMATION | 43
Item 1 - | Legal Proceedings | 43
Item 1A - | Risk Factors | 43
Item 2 - | Unregistered Sales of Equity Securities and Use of Proceeds | 43
Item 6 - | Exhibits | 44
| SIGNATURES | 45

2

PART I – FINANCIAL INFORMATION
ITEM 1. UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)

| Three Months Ended
(Dollars in millions, except per-share amounts) | September 29, 2013 |  | September 28, 2014
Revenues: |  |  |
Products | $ | 4,752 |  |  | $ | 4,909 |
Services | 2,983 |  |  | 2,842 |
| 7,735 |  |  | 7,751 |
Operating costs and expenses: |  |  |
Products | 3,700 |  |  | 3,866 |
Services | 2,577 |  |  | 2,408 |
General and administrative (G&A) | 497 |  |  | 478 |
| 6,774 |  |  | 6,752 |
Operating earnings | 961 |  |  | 999 |
Interest, net | (22 | ) |  | (21 | )
Other, net | 4 |  |  | 1 |
Earnings from continuing operations before income tax | 943 |  |  | 979 |
Provision for income tax, net | 291 |  |  | 285 |
Earnings from continuing operations | 652 |  |  | 694 |
Discontinued operations, net of tax of ($2) in 2013 and $1 in 2014 | (1 | ) |  | 2 |
Net earnings | $ | 651 |  |  | $ | 696 |
Earnings per share |  |  |
Basic: |  |  |
Continuing operations | $ | 1.86 |  |  | $ | 2.09 |
Discontinued operations | — |  |  | 0.01 |
Net earnings | $ | 1.86 |  |  | $ | 2.10 |
Diluted: |  |  |
Continuing operations | $ | 1.84 |  |  | $ | 2.05 |
Discontinued operations | — |  |  | 0.01 |
Net earnings | $ | 1.84 |  |  | $ | 2.06 |

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.
3

CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)

| Nine Months Ended
(Dollars in millions, except per-share amounts) | September 29, 2013 |  | September 28, 2014
Revenues: |  |  |
Products | $ | 13,981 |  |  | $ | 14,005 |
Services | 8,902 |  |  | 8,485 |
| 22,883 |  |  | 22,490 |
Operating costs and expenses: |  |  |
Products | 10,979 |  |  | 10,967 |
Services | 7,633 |  |  | 7,246 |
G&A | 1,506 |  |  | 1,455 |
| 20,118 |  |  | 19,668 |
Operating earnings | 2,765 |  |  | 2,822 |
Interest, net | (63 | ) |  | (67 | )
Other, net | 4 |  |  | 2 |
Earnings from continuing operations before income tax | 2,706 |  |  | 2,757 |
Provision for income tax, net | 844 |  |  | 821 |
Earnings from continuing operations | 1,862 |  |  | 1,936 |
Discontinued operations, net of tax of $1 in 2013 and ($38) in 2014 | — |  |  | (104 | )
Net earnings | $ | 1,862 |  |  | $ | 1,832 |
Earnings per share |  |  |
Basic: |  |  |
Continuing operations | $ | 5.31 |  |  | $ | 5.75 |
Discontinued operations | — |  |  | (0.31 | )
Net earnings | $ | 5.31 |  |  | $ | 5.44 |
Diluted: |  |  |
Continuing operations | $ | 5.27 |  |  | $ | 5.64 |
Discontinued operations | — |  |  | (0.30 | )
Net earnings | $ | 5.27 |  |  | $ | 5.34 |

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.
4

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

| Three Months Ended | Nine Months Ended
(Dollars in millions) | September 29, 2013 |  | September 28, 2014 | September 29, 2013 |  | September 28, 2014
Net earnings | $ | 651 |  |  | $ | 696 |  | $ | 1,862 |  |  | $ | 1,832 |
Gains (losses) on cash flow hedges | 12 |  |  | (60 | ) | — |  |  | (69 | )
Unrealized gains on securities | — |  |  | 1 |  | 7 |  |  | 7 |
Foreign currency translation adjustments | 152 |  |  | (235 | ) | (92 | ) |  | (226 | )
Change in retirement plans' funded status | 95 |  |  | 61 |  | 299 |  |  | 177 |
Other comprehensive income (loss), pretax | 259 |  |  | (233 | ) | 214 |  |  | (111 | )
Provision for income tax, net | 39 |  |  | — |  | 108 |  |  | 41 |
Other comprehensive income (loss), net of tax | 220 |  |  | (233 | ) | 106 |  |  | (152 | )
Comprehensive income | $ | 871 |  |  | $ | 463 |  | $ | 1,968 |  |  | $ | 1,680 |

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.
5

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(Dollars in millions) | December 31, 2013 |  | September 28, 2014
ASSETS |  |  |
Current assets: |  |  |
Cash and equivalents | $ | 5,301 |  |  | $ | 5,105 |
Accounts receivable | 4,370 |  |  | 4,181 |
Contracts in process | 4,780 |  |  | 4,436 |
Inventories | 2,890 |  |  | 3,139 |
Other current assets | 821 |  |  | 1,308 |
Total current assets | 18,162 |  |  | 18,169 |
Noncurrent assets: |  |  |
Property, plant and equipment, net | 3,359 |  |  | 3,322 |
Intangible assets, net | 1,044 |  |  | 929 |
Goodwill | 11,932 |  |  | 11,756 |
Other assets | 997 |  |  | 1,135 |
Total noncurrent assets | 17,332 |  |  | 17,142 |
Total assets | $ | 35,494 |  |  | $ | 35,311 |
LIABILITIES AND SHAREHOLDERS' EQUITY |  |  |
Current liabilities: |  |  |
Short-term debt and current portion of long-term debt | $ | 1 |  |  | $ | 501 |
Accounts payable | 2,216 |  |  | 2,390 |
Customer advances and deposits | 6,584 |  |  | 7,990 |
Other current liabilities | 3,458 |  |  | 3,789 |
Total current liabilities | 12,259 |  |  | 14,670 |
Noncurrent liabilities: |  |  |
Long-term debt | 3,908 |  |  | 3,410 |
Other liabilities | 4,826 |  |  | 4,221 |
Commitments and contingencies (See Note L) |  |  |  |  |
Total noncurrent liabilities | 8,734 |  |  | 7,631 |
Shareholders' equity: |  |  |
Common stock | 482 |  |  | 482 |
Surplus | 2,226 |  |  | 2,467 |
Retained earnings | 19,428 |  |  | 20,631 |
Treasury stock | (6,450 | ) |  | (9,233 | )
Accumulated other comprehensive loss | (1,185 | ) |  | (1,337 | )
Total shareholders' equity | 14,501 |  |  | 13,010 |
Total liabilities and shareholders' equity | $ | 35,494 |  |  | $ | 35,311 |

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.
6

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

| Nine Months Ended
(Dollars in millions) | September 29, 2013 |  | September 28, 2014
Cash flows from operating activities - continuing operations: |  |  |
Net earnings | $ | 1,862 |  |  | $ | 1,832 |
Adjustments to reconcile net earnings to net cash provided by operating activities: |  |  |
Depreciation of property, plant and equipment | 280 |  |  | 285 |
Amortization of intangible assets | 112 |  |  | 91 |
Stock-based compensation expense | 90 |  |  | 94 |
Excess tax benefit from stock-based compensation | (19 | ) |  | (66 | )
Deferred income tax provision | 51 |  |  | 94 |
Discontinued operations, net of tax | — |  |  | 104 |
(Increase) decrease in assets, net of effects of business acquisitions: |  |  |
Accounts receivable | (181 | ) |  | 189 |
Contracts in process | (119 | ) |  | 380 |
Inventories | (212 | ) |  | (259 | )
Increase (decrease) in liabilities, net of effects of business acquisitions: |  |  |
Accounts payable | (1 | ) |  | 174 |
Customer advances and deposits | 16 |  |  | 1,231 |
Income taxes payable | 80 |  |  | 148 |
Other current and noncurrent liabilities | (183 | ) |  | (238 | )
Other, net | (223 | ) |  | (261 | )
Net cash provided by operating activities | 1,553 |  |  | 3,798 |
Cash flows from investing activities - continuing operations: |  |  |
Purchases of held-to-maturity securities | — |  |  | (500 | )
Capital expenditures | (267 | ) |  | (337 | )
Other, net | 55 |  |  | 11 |
Net cash used by investing activities | (212 | ) |  | (826 | )
Cash flows from financing activities - continuing operations: |  |  |
Purchases of common stock | (696 | ) |  | (3,117 | )
Dividends paid | (394 | ) |  | (618 | )
Proceeds from option exercises | 484 |  |  | 475 |
Other | 46 |  |  | 66 |
Net cash used by financing activities | (560 | ) |  | (3,194 | )
Net cash (used) provided by discontinued operations | (12 | ) |  | 26 |
Net increase (decrease) in cash and equivalents | 769 |  |  | (196 | )
Cash and equivalents at beginning of period | 3,296 |  |  | 5,301 |
Cash and equivalents at end of period | $ | 4,065 |  |  | $ | 5,105 |
Supplemental cash flow information: |  |  |
Cash payments for: |  |  |
Income taxes | $ | 713 |  |  | $ | 573 |
Interest | $ | 66 |  |  | $ | 65 |

The accompanying Notes to Unaudited Consolidated Financial Statements are an integral part of these statements.
7

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)

| Common Stock |  | Retained |  | Treasury |  | Accumulated Other Comprehensive |  | Total Shareholders’
(Dollars in millions) | Par |  | Surplus |  | Earnings |  | Stock |  | Loss |  | Equity
Balance, December 31, 2012 | $ | 482 |  |  | $ | 1,988 |  |  | $ | 17,860 |  |  | $ | (6,165 | ) |  | $ | (2,775 | ) |  | $ | 11,390 |
Net earnings | — |  |  | — |  |  | 1,862 |  |  | — |  |  | — |  |  | 1,862 |
Cash dividends declared | — |  |  | — |  |  | (591 | ) |  | — |  |  | — |  |  | (591 | )
Stock-based awards | — |  |  | 173 |  |  | — |  |  | 383 |  |  | — |  |  | 556 |
Shares purchased | — |  |  | — |  |  | — |  |  | (718 | ) |  | — |  |  | (718 | )
Other comprehensive income | — |  |  | — |  |  | — |  |  | — |  |  | 106 |  |  | 106 |
Balance, September 29, 2013 | $ | 482 |  |  | $ | 2,161 |  |  | $ | 19,131 |  |  | $ | (6,500 | ) |  | $ | (2,669 | ) |  | $ | 12,605 |
Balance, December 31, 2013 | $ | 482 |  |  | $ | 2,226 |  |  | $ | 19,428 |  |  | $ | (6,450 | ) |  | $ | (1,185 | ) |  | $ | 14,501 |
Net earnings | — |  |  | — |  |  | 1,832 |  |  | — |  |  | — |  |  | 1,832 |
Cash dividends declared | — |  |  | — |  |  | (629 | ) |  | — |  |  | — |  |  | (629 | )
Stock-based awards | — |  |  | 241 |  |  | — |  |  | 377 |  |  | — |  |  | 618 |
Shares purchased | — |  |  | — |  |  | — |  |  | (3,160 | ) |  | — |  |  | (3,160 | )
Other comprehensive loss | — |  |  | — |  |  | — |  |  | — |  |  | (152 | ) |  | (152 | )
Balance, September 28, 2014 | $ | 482 |  |  | $ | 2,467 |  |  | $ | 20,631 |  |  | $ | (9,233 | ) |  | $ | (1,337 | ) |  | $ | 13,010 |

The accompanying Notes to Consolidated Financial Statements are an integral part of these statements.
8

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per-share amounts or unless otherwise noted)
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Consolidation and Classification. The unaudited Consolidated Financial Statements include the accounts of General Dynamics Corporation and our wholly owned and majority-owned subsidiaries. We eliminate all inter-company balances and transactions in the unaudited Consolidated Financial Statements.
Consistent with defense industry practice, we classify assets and liabilities related to long-term production contracts as current, even though some of these amounts may not be realized within one year.
Interim Financial Statements. The unaudited Consolidated Financial Statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. These rules and regulations permit some of the information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) to be condensed or omitted.
Our fiscal quarters are 13 weeks in length. Because our fiscal year ends on December 31, the number of days in our first and fourth quarters varies slightly from year to year. Operating results for the three- and nine-month periods ended September 28, 2014, are not necessarily indicative of the results that may be expected for the year ending December 31, 2014.
The unaudited Consolidated Financial Statements contain all adjustments that are of a normal recurring nature necessary for a fair presentation of our results of operations and financial condition for the three- and nine-month periods ended September 29, 2013, and September 28, 2014.
These unaudited Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2013. The unaudited Consolidated Financial Statements have been restated to reflect the results of operations of our axle business in discontinued operations (see further discussion below).
Revenue Recognition. We account for revenues and earnings using the percentage-of-completion method. Under this method, contract costs and revenues are recognized as the work progresses, either as the products are produced or as services are rendered. We estimate the profit on a contract as the difference between the total estimated revenue and costs to complete a contract and recognize that profit over the life of the contract. If at any time the estimate of contract profitability indicates an anticipated loss on the contract, we recognize the loss in the quarter it is identified.
We review and update our contract estimates regularly. We recognize changes in estimated profit on contracts under the reallocation method. Under the reallocation method, the impact of a revision in estimate is recognized prospectively over the remaining contract term. The net increase in our operating earnings (and on a per-share basis) from the favorable impact of revisions in contract estimates totaled $105 ($0.19) and $296 ($0.54) for the three- and nine-month periods ended September 29, 2013, and $13 ($0.02) and $103 ($0.20) for the three- and nine-month periods ended September 28, 2014, respectively. While no revisions on any one contract were material to our unaudited Consolidated Financial Statements in the third quarter and first nine months of 2014, the amount decreased compared with the prior-year periods as 2013 included higher favorable revisions in contract estimates on several programs that neared completion in the Combat Systems and Information Systems and Technology groups.
9

In the second quarter of 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers. ASU 2014-09 prescribes a single, common revenue standard that replaces most existing revenue recognition guidance in GAAP. The standard outlines a five-step model, whereby revenue is recognized as performance obligations within a contract are satisfied. The standard also requires new, expanded disclosures regarding revenue recognition. ASU 2014-09 is effective in the first quarter of 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We have not yet selected a transition method nor have we determined the effect of the standard on our consolidated financial statements.
The required adoption of the ASU in 2017 will preclude our use of the reallocation method of recognizing revisions in estimated profit on contracts discussed above. Because changes in estimated profit will be recognized in the period they are identified (cumulative catch-up method), rather than prospectively over the remaining contract term, we expect that the impact of revisions of contract estimates may be larger and potentially more variable from period to period. Anticipated losses on contracts will continue to be recognized in the quarter they are identified.
Discontinued Operations. In June 2014, we committed to a plan to sell our axle business in the Combat Systems group. Accordingly, the assets and liabilities of the business, including an allocation of goodwill, were reported as held for sale and included in other current assets and liabilities on the unaudited Consolidated Balance Sheets. When a business is held for sale, management is required to evaluate the net assets of the business for impairment based on its fair value less cost to sell. Based on this analysis, we recognized a $106 after-tax loss in the second quarter.
In late 2013, we settled our litigation with the U.S. Navy related to a terminated contract in the company’s discontinued tactical military aircraft business. Under the terms of the settlement agreement, the Navy received a $198 credit that will be utilized over several years as the company renders design and construction services on the DDG-1000 program. This activity is reported in net cash from discontinued operations on the Consolidated Statements of Cash Flows.
Subsequent Events. We have evaluated material events and transactions that have occurred after September 28, 2014, and concluded that no subsequent events have occurred that require adjustment to or disclosure in this Form 10-Q.
B. ACQUISITIONS, INTANGIBLE ASSETS AND GOODWILL
We did not acquire any businesses in 2013 or the first nine months of 2014.
The changes in the carrying amount of goodwill by reporting unit for the nine months ended
September 28, 2014, were as follows:

| Aerospace |  | Combat Systems |  | Marine Systems |  | Information Systems and Technology |  | Total Goodwill
December 31, 2013 (a) | $ | 2,741 |  |  | $ | 2,849 |  |  | $ | 289 |  |  | $ | 6,053 |  |  | $ | 11,932 |
Other (b) | (104 | ) |  | (59 | ) |  | — |  |  | (13 | ) |  | (176 | )
September 28, 2014 | $ | 2,637 |  |  | $ | 2,790 |  |  | $ | 289 |  |  | $ | 6,040 |  |  | $ | 11,756 |

(a)Goodwill on December 31, 2013, in the Information Systems and Technology reporting unit is net of $1,994 of accumulated impairment losses.
(b)Consists primarily of adjustments for foreign currency translation.
10

Intangible assets consisted of the following:

| Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount |  | Gross Carrying Amount | Accumulated Amortization | Net Carrying Amount
| December 31, 2013 |  | September 28, 2014
Contract and program intangible assets* | $ | 1,790 |  | $ | (1,189 | ) | $ | 601 |  |  | $ | 1,626 |  | $ | (1,102 | ) | $ | 524 |
Trade names and trademarks | 507 |  | (103 | ) | 404 |  |  | 487 |  | (118 | ) | 369 |
Technology and software | 130 |  | (92 | ) | 38 |  |  | 129 |  | (94 | ) | 35 |
Other intangible assets | 155 |  | (154 | ) | 1 |  |  | 155 |  | (154 | ) | 1 |
Total intangible assets | $ | 2,582 |  | $ | (1,538 | ) | $ | 1,044 |  |  | $ | 2,397 |  | $ | (1,468 | ) | $ | 929 |

* Consists of acquired backlog and probable follow-on work and related customer relationships.
The decrease in the gross carrying amount and accumulated amortization of contract and program intangible assets from December 31, 2013, to September 28, 2014, is primarily due to the write-off of fully amortized assets in the Information Systems and Technology group. Amortization expense was $33 and $112 for the three- and nine-month periods ended September 29, 2013, and $30 and $91 for the three- and nine-month periods ended September 28, 2014, respectively.
C. EARNINGS PER SHARE
Earnings per Share. We compute basic earnings per share (EPS) using net earnings for the period and the weighted average number of common shares outstanding during the period. Basic weighted average shares outstanding have decreased throughout 2013 and 2014 due to share repurchases. Diluted EPS incorporates the additional shares issuable upon the assumed exercise of stock options and the release of restricted shares and restricted stock units (RSUs). Diluted EPS in 2014 also includes contingently issuable shares associated with the settlement of our accelerated share repurchase (ASR) program that expires in the fourth quarter of 2014. See Note J for additional details of our share repurchases and the ASR.
Basic and diluted weighted average shares outstanding were as follows (in thousands):

| Three Months Ended | Nine Months Ended
| September 29, 2013 | September 28, 2014 | September 29, 2013 | September 28, 2014
Basic weighted average shares outstanding | 349,337 |  | 331,811 |  | 350,774 |  | 336,911 |
Dilutive effect of other securities* | 3,581 |  | 6,370 |  | 2,348 |  | 6,203 |
Diluted weighted average shares outstanding | 352,918 |  | 338,181 |  | 353,122 |  | 343,114 |

* Excludes the following outstanding options to purchase shares of common stock and nonvested restricted stock/RSUs because the effect of including these securities would be antidilutive: 2013 - 10,992 and 2014 - 3,446.
D. FAIR VALUE
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market in an orderly transaction between marketplace participants. Various valuation approaches can be used to determine fair value, each requiring different valuation inputs. The following hierarchy classifies the inputs used to determine fair value into three levels:
11

• | Level 1 – quoted prices in active markets for identical assets or liabilities;

• | Level 2 – inputs, other than quoted prices, observable by a marketplace participant either directly or indirectly; and

• | Level 3 – unobservable inputs significant to the fair value measurement.

We did not have any significant non-financial assets or liabilities measured at fair value on December 31, 2013, or September 28, 2014, except for our assets held for sale (discussed in Note A) that were measured at fair value using Level 3 inputs. Our estimate of fair value considered the discounted projected cash flows of the underlying operations and an evaluation of market prices for similar assets.
Our financial instruments include cash and equivalents, marketable securities and other investments; accounts receivable and accounts payable; short- and long-term debt; and derivative financial instruments. The carrying values of cash and equivalents, accounts receivable and accounts payable on the Consolidated Balance Sheets approximate their fair value. The following tables present the fair values of our other financial assets and liabilities on December 31, 2013, and September 28, 2014, and the basis for determining their fair values:

| Carrying Value |  | Fair Value |  | Quoted Prices in Active Markets for Identical Assets (Level 1) |  | Significant Other Observable Inputs (Level 2) (a)
Financial assets (liabilities) (b) | December 31, 2013
Other investments | $ | 183 |  |  | $ | 183 |  |  | $ | 134 |  |  | $ | 49 |
Derivatives | 10 |  |  | 10 |  |  | — |  |  | 10 |
Long-term debt, including current portion | (3,909 | ) |  | (3,758 | ) |  | — |  |  | (3,758 | )
| September 28, 2014
Held-to-maturity marketable securities | $ | 500 |  |  | $ | 500 |  |  | $ | 10 |  |  | $ | 490 |
Other investments | 170 |  |  | 170 |  |  | 106 |  |  | 64 |
Derivatives | (61 | ) |  | (61 | ) |  | — |  |  | (61 | )
Long-term debt, including current portion | (3,911 | ) |  | (3,879 | ) |  | — |  |  | (3,879 | )

(a)Determined under a market approach using valuation models that incorporate observable inputs such as interest rates, bond yields and quoted prices for similar assets and liabilities.
(b)We had no Level 3 financial instruments on December 31, 2013, or September 28, 2014.
E. INCOME TAXES
Deferred Taxes. Our net deferred tax asset (liability) was included on the Consolidated Balance Sheets in other assets and liabilities as follows:

| December 31, 2013 |  | September 28, 2014
Current deferred tax asset | $ | 35 |  |  | $ | 32 |
Current deferred tax liability | (300 | ) |  | (563 | )
Noncurrent deferred tax asset | 462 |  |  | 597 |
Noncurrent deferred tax liability | (135 | ) |  | (92 | )
Net deferred tax asset (liability) | $ | 62 |  |  | $ | (26 | )

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Tax Uncertainties. For all periods open to examination by tax authorities, we periodically assess our liabilities and contingencies based on the latest available information. Where we believe there is more than a 50 percent chance that our tax position will not be sustained, we record our best estimate of the resulting tax liability, including interest, in the Consolidated Financial Statements. We include any interest or penalties incurred in connection with income taxes as part of income tax expense.
We participate in the Internal Revenue Service (IRS) Compliance Assurance Process, a real-time audit of our consolidated corporate federal income tax return. The IRS has examined our consolidated federal income tax returns through 2012. We do not expect the resolution of tax matters for open years to have a material impact on our results of operations, financial condition, cash flows or effective tax rate.
Based on all known facts and circumstances and current tax law, the total amount of unrecognized tax benefits on September 28, 2014, is not material to our results of operations, financial condition or cash flows, and if recognized, would not have a material impact on our effective tax rate. In addition, there are no tax positions for which it is reasonably possible that the unrecognized tax benefits will significantly vary over the next 12 months, producing, individually or in the aggregate, a material effect on our results of operations, financial condition or cash flows.
F. CONTRACTS IN PROCESS
Contracts in process represent recoverable costs and, where applicable, accrued profit related to long-term contracts that have been inventoried until the customer is billed, and consisted of the following:

| December 31, 2013 |  | September 28, 2014
Contract costs and estimated profits | $ | 7,961 |  |  | $ | 7,209 |
Other contract costs | 1,178 |  |  | 1,073 |
| 9,139 |  |  | 8,282 |
Advances and progress payments | (4,359 | ) |  | (3,846 | )
Total contracts in process | $ | 4,780 |  |  | $ | 4,436 |

Contract costs consist primarily of labor, material, overhead and G&A expenses. Other contract costs represent amounts that are not currently allocable to government contracts, such as a portion of our estimated workers’ compensation obligations, other insurance-related assessments, pension and other post-retirement benefits and environmental expenses. These costs will become allocable to contracts generally after they are paid. We expect to recover these costs through ongoing business, including existing backlog and probable follow-on contracts. If the backlog in the future does not support the continued deferral of these costs, the profitability of our remaining contracts could be adversely affected.
G. INVENTORIES
Our inventories represent primarily business-jet components and are stated at the lower of cost or net realizable value. Work-in-process represents largely labor, material and overhead costs associated with aircraft in the manufacturing process and is based primarily on the estimated average unit cost of the units in a production lot. Raw materials are valued primarily on the first-in, first-out method. We record pre-owned aircraft acquired in connection with the sale of new aircraft at the lower of the trade-in value or the estimated net realizable value.
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Inventories consisted of the following:

| December 31, 2013 |  | September 28, 2014
Work in process | $ | 1,633 |  |  | $ | 1,843 |
Raw materials | 1,210 |  |  | 1,244 |
Finished goods | 29 |  |  | 23 |
Pre-owned aircraft | 18 |  |  | 29 |
Total inventories | $ | 2,890 |  |  | $ | 3,139 |

H. DEBT
Debt consisted of the following:

|  | December 31, 2013 |  | September 28, 2014
Fixed-rate notes due: | Interest Rate |  |  |
January 2015 | 1.375% | $ | 500 |  |  | $ | 500 |
July 2016 | 2.250% | 500 |  |  | 500 |
November 2017 | 1.000% | 896 |  |  | 897 |
July 2021 | 3.875% | 499 |  |  | 499 |
November 2022 | 2.250% | 991 |  |  | 992 |
November 2042 | 3.600% | 498 |  |  | 498 |
Other | Various | 25 |  |  | 25 |
Total debt |  | 3,909 |  |  | 3,911 |
Less current portion |  | 1 |  |  | 501 |
Long-term debt |  | $ | 3,908 |  |  | $ | 3,410 |

Our fixed-rate notes are fully and unconditionally guaranteed by several of our 100-percent-owned subsidiaries (see Note O for condensed consolidating financial statements). We have the option to redeem the notes prior to their maturity in whole or part for the principal plus any accrued but unpaid interest and applicable make-whole amounts. As we approach the maturity date of the fixed-rate notes due in January 2015, we will determine whether to repay these notes with cash on hand or refinance the obligation.
On September 28, 2014, we had no commercial paper outstanding, but we maintain the ability to access the commercial paper market in the future. We have $2 billion in committed bank credit facilities that provide backup liquidity to our commercial paper program. These credit facilities include a $1 billion multi-year facility expiring in July 2016 and a $1 billion multi-year facility expiring in July 2018. These facilities are required by rating agencies to support our commercial paper issuances. We may renew or replace, in whole or part, these credit facilities at or prior to their expiration dates. Our commercial paper issuances and the bank credit facilities are guaranteed by several of our 100-percent-owned subsidiaries. In addition, we have approximately $265 in committed bank credit facilities to provide backup liquidity to our European businesses.
Our financing arrangements contain a number of customary covenants and restrictions. We were in compliance with all material covenants on September 28, 2014.
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I. OTHER LIABILITIES
A summary of significant other liabilities by balance sheet caption follows:

| December 31, 2013 |  | September 28, 2014
Salaries and wages | $ | 801 |  |  | $ | 720 |
Workers' compensation | 497 |  |  | 466 |
Retirement benefits | 303 |  |  | 301 |
Deferred income taxes | 300 |  |  | 563 |
Income taxes payable | 36 |  |  | 115 |
Other (a) | 1,521 |  |  | 1,624 |
Total other current liabilities | $ | 3,458 |  |  | $ | 3,789 |
Retirement benefits | $ | 3,064 |  |  | $ | 2,612 |
Customer deposits on commercial contracts | 677 |  |  | 502 |
Deferred income taxes | 135 |  |  | 92 |
Other (b) | 950 |  |  | 1,015 |
Total other liabilities | $ | 4,826 |  |  | $ | 4,221 |

(a)Consists primarily of dividends payable, environmental remediation reserves, warranty reserves, liabilities of discontinued operations and insurance-related costs.
(b)Consists primarily of liabilities for warranty reserves and workers' compensation and liabilities of discontinued operations.
J. SHAREHOLDERS' EQUITY
Dividends per Share. Dividends declared per share were $0.56 and $1.68 for the three- and nine-month periods ended September 29, 2013, and $0.62 and $1.86 for the three- and nine-month periods ended September 28, 2014, respectively. Cash dividends paid were $196 and $394 for the three- and nine-month periods ended September 29, 2013, and $207 and $618 for the three- and nine-month periods ended September 28, 2014. In advance of possible tax increases, we accelerated our first quarter 2013 dividend payments to December 2012.
Share Repurchases. In the first nine months of 2014, we repurchased approximately 28.8 million of our outstanding shares. Of this amount, 11.4 million shares were repurchased on January 24, 2014, for $1.2 billion under an ASR program facilitated through a financial institution. Our final cost of the ASR program will be determined based on the weighted-average daily market price of our stock during the term of the agreement, which expires in the fourth quarter of 2014. On February 5, 2014, with shares from the prior authorization largely exhausted by the ASR program, the board of directors authorized management to repurchase 20 million additional shares of common stock on the open market. Subsequently, we repurchased an additional 17.4 million shares for approximately $2 billion. On September 28, 2014, 2.6 million shares remained authorized by our board of directors for repurchase, approximately 1 percent of our total shares outstanding. We repurchased 9.2 million shares for a total of approximately $700 in the first nine months of 2013.
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Accumulated Other Comprehensive Loss. The changes, pretax and net of tax, in each component of accumulated other comprehensive loss (AOCL) consisted of the following:

| Gains on Cash Flow Hedges | Unrealized Gains on Securities | Foreign Currency Translation Adjustments | Changes in Retirement Plans’ Funded Status | AOCL
Balance, December 31, 2012 | $ | 6 |  | $ | 7 |  | $ | 1,092 |  | $ | (3,880 | ) | $ | (2,775 | )
Other comprehensive (loss) income, pretax | — |  | 7 |  | (92 | ) | 299 |  | 214 |
(Benefit) provision for income tax, net | (1 | ) | 2 |  | (1 | ) | 108 |  | 108 |
Other comprehensive (loss) income, net of tax | 1 |  | 5 |  | (91 | ) | 191 |  | 106 |
Balance, September 29, 2013 | $ | 7 |  | $ | 12 |  | $ | 1,001 |  | $ | (3,689 | ) | $ | (2,669 | )

| Gains (Losses) on Cash Flow Hedges | Unrealized Gains on Securities | Foreign Currency Translation Adjustments | Changes in Retirement Plans’ Funded Status | AOCL
Balance, December 31, 2013 | $ | 9 |  | $ | 15 |  | $ | 974 |  | $ | (2,183 | ) | $ | (1,185 | )
Other comprehensive (loss) income, pretax | (69 | ) | 7 |  | (226 | ) | 177 |  | (111 | )
(Benefit) provision for income tax, net | (18 | ) | 3 |  | (5 | ) | 61 |  | 41 |
Other comprehensive (loss) income, net of tax | (51 | ) | 4 |  | (221 | ) | 116 |  | (152 | )
Balance, September 28, 2014 | $ | (42 | ) | $ | 19 |  | $ | 753 |  | $ | (2,067 | ) | $ | (1,337 | )

Amounts reclassified out of AOCL related primarily to changes in retirement plans' funded status and consisted of pretax recognized net actuarial losses of $336 and $228 for the nine-month periods ended September 29, 2013, and September 28, 2014, respectively. This was partially offset by pretax amortization of prior service credit of $40 and $51 for the nine-month periods ended September 29, 2013, and September 28, 2014, respectively. These AOCL components are included in our net periodic pension and other post-retirement benefit cost. See Note M for additional details.
K. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We are exposed to market risk, primarily from foreign currency exchange rates, interest rates, commodity prices and investments. We may use derivative financial instruments to hedge some of these risks as described below. We do not use derivatives for trading or speculative purposes.
Foreign Currency Risk and Hedging Activities. Our foreign currency exchange rate risk related to receipts from customers, payments to suppliers and inter-company transactions denominated in foreign currencies. To the extent possible, we include terms in our contracts that are designed to protect us from this risk. Otherwise, we enter into derivative financial instruments, principally foreign currency forward purchase and sale contracts, designed to offset and minimize our risk. The two-year average maturity of these instruments matches the duration of the activities that are at risk. We had $1.7 billion in notional forward exchange contracts outstanding on December 31, 2013, and $5 billion on September 28, 2014. The increase in the amount of outstanding foreign currency forward contracts is due to significant international contract awards in 2014. We recognize derivative financial instruments on the Consolidated Balance Sheets at fair value (see Note D).
We record changes in the fair value of derivative financial instruments in operating costs and expenses in the Consolidated Statements of Earnings or in other comprehensive loss (OCL) within the
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Consolidated Statements of Comprehensive Income depending on whether the derivative is designated and qualifies for hedge accounting. Gains and losses related to derivatives that qualify as cash flow hedges are deferred in OCL until the underlying transaction is reflected in earnings. We adjust derivative financial instruments not designated as cash flow hedges to market value each period and record the gain or loss in the Consolidated Statements of Earnings. The gains and losses on these instruments generally offset losses and gains on the assets, liabilities and other transactions being hedged. Gains and losses resulting from hedge ineffectiveness are recognized in the Consolidated Statements of Earnings for all derivative financial instruments, regardless of designation.
Net gains and losses recognized in earnings, including gains and losses related to hedge ineffectiveness, were not material to our results of operations for the three- and nine-month periods ended September 29, 2013, and September 28, 2014. Net gains and losses reclassified to earnings from OCL were not material to our results of operations for the three- and nine-month periods ended September 29, 2013, and September 28, 2014, and we do not expect the amount of these gains and losses that will be reclassified to earnings during the next 12 months to be material.
We had no material derivative financial instruments designated as fair value or net investment hedges on December 31, 2013, or September 28, 2014.
Interest Rate Risk. Our financial instruments subject to interest rate risk include fixed-rate long-term debt obligations and variable-rate commercial paper. However, the risk associated with these instruments is not material.
Commodity Price Risk. We are subject to risk of rising labor and commodity prices, primarily on long-term fixed-price contracts. To the extent possible, we include terms in our contracts that are designed to protect us from this risk. Some of the protective terms included in our contracts are considered derivatives but are not accounted for separately because they are clearly and closely related to the host contract. We have not entered into any material commodity hedging contracts but may do so as circumstances warrant. We do not believe that changes in labor or commodity prices will have a material impact on our results of operations or cash flows.
Investment Risk. Our investment policy allows for purchases of fixed-income securities with an investment-grade rating and a maximum maturity of up to five years. On September 28, 2014, we held $5.1 billion in cash and equivalents and $500 of marketable securities reported in other current assets. Our marketable securities had an average duration of four months and an average credit rating of AA-. Historically, we have not experienced material gains or losses on these instruments due to changes in interest rates or market values.
Foreign Currency Financial Statement Translation. We translate foreign currency balance sheets from our international businesses' functional currency (generally the respective local currency) to U.S. dollars at the end-of-period exchange rates, and statements of earnings at the average exchange rates for each period. The resulting foreign currency translation adjustments are a component of OCL.
We do not hedge the fluctuation in reported revenues and earnings resulting from the translation of these international operations' results into U.S. dollars. The impact of translating our international operations’ revenues and earnings into U.S. dollars was not material to our results of operations for the three- and nine-month periods ended September 29, 2013, or September 28, 2014. In addition, the effect of changes in foreign exchange rates on non-U.S. cash balances was not material in the first nine months of either 2013 or 2014.
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L. COMMITMENTS AND CONTINGENCIES
Litigation
Various claims and other legal proceedings incidental to the normal course of business are pending or threatened against us. These matters relate to such issues as government investigations and claims, the protection of the environment, asbestos-related claims and employee-related matters. The nature of litigation is such that we cannot predict the outcome of these matters. However, based on information currently available, we believe any potential liabilities in these proceedings, individually or in the aggregate, will not have a material impact on our results of operations, financial condition or cash flows.
Environmental
We are subject to and affected by a variety of federal, state, local and foreign environmental laws and regulations. We are directly or indirectly involved in environmental investigations or remediation at some of our current and former facilities and third-party sites that we do not own but where we have been designated a Potentially Responsible Party (PRP) by the U.S. Environmental Protection Agency or a state environmental agency. Based on historical experience, we expect that a significant percentage of the total remediation and compliance costs associated with these facilities will continue to be allowable contract costs and, therefore, recoverable under U.S. government contracts.
As required, we provide financial assurance for certain sites undergoing or subject to investigation or remediation. We accrue environmental costs when it is probable that a liability has been incurred and the amount can be reasonably estimated. Where applicable, we seek insurance recovery for costs related to environmental liabilities. We do not record insurance recoveries before collection is considered probable. Based on all known facts and analyses, we do not believe that our liability at any individual site, or in the aggregate, arising from such environmental conditions, will be material to our results of operations, financial condition or cash flows. We also do not believe that the range of reasonably possible additional loss beyond what has been recorded would be material to our results of operations, financial condition or cash flows.
Other
Portugal Program. In the third quarter of 2014, we reached a settlement with the Portuguese Ministry of National Defense and Ministry of Economy relating to a dispute arising from a contract in our Combat Systems group’s European Land Systems business to provide armored vehicles. The settlement provides for the delivery of vehicles and a significant reduction in our offset obligations and related bank guarantees. The settlement did not have a material impact on our results of operations, financial condition or cash flows.
Government Contracts. As a government contractor, we are subject to U.S. government audits and investigations relating to our operations, including claims for fines, penalties, and compensatory and treble damages. We believe the outcome of such ongoing government audits and investigations will not have a material impact on our results of operations, financial condition or cash flows.
In the performance of our contracts, we routinely request contract modifications that require additional funding from the customer. Most often, these requests are due to customer-directed changes in scope of work. While we are entitled to recovery of these costs under our contracts, the administrative process with our customer may be protracted. Based upon the circumstances, we periodically file claims or requests for equitable adjustment (REAs). In some cases, these requests are disputed by our customer. We believe our outstanding modifications and other claims will be resolved without material impact to our results of operations, financial condition or cash flows.
Letters of Credit and Guarantees. In the ordinary course of business, we have entered into letters of credit, bank guarantees, surety bonds and other similar arrangements with financial institutions and insurance carriers totaling approximately $1.2 billion on September 28, 2014. In addition, from time to
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time and in the ordinary course of business, we contractually guarantee the payment or performance obligations of our subsidiaries arising under certain contracts.
Aircraft Trade-ins. In connection with orders for new aircraft in funded contract backlog, our Aerospace group has outstanding options with some customers to trade in aircraft as partial consideration in their new-aircraft transaction. These trade-in commitments are structured to establish the fair market value of the trade-in aircraft at a date generally 120 or fewer days preceding delivery of the new aircraft to the customer. At that time, the customer is required to either exercise the option or allow its expiration. Any excess of the pre-established trade-in price above the fair market value at the time the new aircraft is delivered is treated as a reduction of revenue in the new-aircraft sales transaction.
Product Warranties. We provide warranties to our customers associated with certain product sales. We record estimated warranty costs in the period in which the related products are delivered. The warranty liability recorded at each balance sheet date is generally based on the number of months of warranty coverage remaining for products delivered and the average historical monthly warranty payments. Warranty obligations incurred in connection with long-term production contracts are accounted for within the contract estimates at completion. Our other warranty obligations, primarily for business-jet aircraft, are included in other current and noncurrent liabilities on the Consolidated Balance Sheets.
The changes in the carrying amount of warranty liabilities for the nine-month periods ended September 29, 2013, and September 28, 2014, were as follows:

Nine Months Ended | September 29, 2013 |  | September 28, 2014
Beginning balance | $ | 316 |  |  | $ | 354 |
Warranty expense | 84 |  |  | 108 |
Payments | (50 | ) |  | (54 | )
Adjustments | (4 | ) |  | 6 |
Ending balance | $ | 346 |  |  | $ | 414 |

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M. RETIREMENT PLANS
We provide defined-contribution benefits, as well as defined-benefit pension and other post-retirement benefits, to eligible employees.
Net periodic cost associated with our defined-benefit pension and other post-retirement benefit plans for the three- and nine-month periods ended September 29, 2013, and September 28, 2014, consisted of the following:

| Pension Benefits | Other Post-retirement Benefits
Three Months Ended | September 29, 2013 |  | September 28, 2014 | September 29, 2013 |  | September 28, 2014
Service cost | $ | 80 |  |  | $ | 49 |  | $ | 4 |  |  | $ | 3 |
Interest cost | 124 |  |  | 133 |  | 13 |  |  | 13 |
Expected return on plan assets | (148 | ) |  | (164 | ) | (7 | ) |  | (8 | )
Recognized net actuarial loss | 106 |  |  | 73 |  | 6 |  |  | 2 |
Amortization of prior service (credit) cost | (16 | ) |  | (16 | ) | 2 |  |  | — |
Net periodic cost | $ | 146 |  |  | $ | 75 |  | $ | 18 |  |  | $ | 10 |

| Pension Benefits | Other Post-retirement Benefits
Nine Months Ended | September 29, 2013 |  | September 28, 2014 | September 29, 2013 |  | September 28, 2014
Service cost | $ | 240 |  |  | $ | 145 |  | $ | 12 |  |  | $ | 9 |
Interest cost | 372 |  |  | 399 |  | 39 |  |  | 39 |
Expected return on plan assets | (444 | ) |  | (492 | ) | (21 | ) |  | (24 | )
Recognized net actuarial loss | 318 |  |  | 221 |  | 18 |  |  | 7 |
Amortization of prior service (credit) cost | (46 | ) |  | (50 | ) | 6 |  |  | (1 | )
Net periodic cost | $ | 440 |  |  | $ | 223 |  | $ | 54 |  |  | $ | 30 |

Our contractual arrangements with the U.S. government provide for the recovery of contributions to our pension and other post-retirement benefit plans covering employees working in our defense business groups. For non-funded plans, our government contracts allow us to recover claims paid. Following payment, these recoverable amounts are allocated to contracts and billed to the customer in accordance with the Cost Accounting Standards (CAS) and specific contractual terms. For some of these plans, the cumulative pension and post-retirement benefit cost exceeds the amount currently allocable to contracts. To the extent recovery of the cost is considered probable based on our backlog and probable follow-on contracts, we defer the excess in contracts in process on the Consolidated Balance Sheets until the cost is allocable to contracts. See Note F for discussion of our deferred contract costs. For other plans, the amount allocated to contracts and included in revenues has exceeded the plans’ cumulative benefit cost. We have deferred recognition of these excess earnings to provide a better matching of revenues and expenses. These deferrals have been classified against the plan assets on the Consolidated Balance Sheets.
In 2011, changes were made to the CAS to harmonize the regulations with the Pension Protection Act of 2006 (PPA). For certain contracts awarded prior to February 27, 2012, we are entitled to recover additional pension costs from our customers resulting from the CAS harmonization with the PPA. We submitted REAs of approximately $165 for these contracts in 2012. These REAs remained outstanding on September 28, 2014, and are subject to negotiation with our customer, the U.S. Department of Defense.
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N. BUSINESS GROUP INFORMATION
We operate in four business groups: Aerospace, Combat Systems, Marine Systems and Information Systems and Technology. We organize our business groups in accordance with the nature of products and services offered. These business groups derive their revenues from business aviation; combat vehicles, weapons systems and munitions; military and commercial shipbuilding and related services; and communication and information technology systems and solutions, respectively. We measure each group’s profit based on operating earnings. As a result, we do not allocate net interest, other income and expense items, and income taxes to our business groups.
Summary financial information for each of our business groups follows:

| Revenues | Operating Earnings
Three Months Ended | September 29, 2013 | September 28, 2014 | September 29, 2013 | September 28, 2014
Aerospace | $ | 2,152 |  | $ | 2,289 |  | $ | 369 |  | $ | 411 |
Combat Systems | 1,306 |  | 1,395 |  | 228 |  | 232 |
Marine Systems | 1,697 |  | 1,820 |  | 170 |  | 170 |
Information Systems and Technology | 2,580 |  | 2,247 |  | 216 |  | 202 |
Corporate* | — |  | — |  | (22 | ) | (16 | )
| $ | 7,735 |  | $ | 7,751 |  | $ | 961 |  | $ | 999 |

| Revenues | Operating Earnings
Nine Months Ended | September 29, 2013 | September 28, 2014 | September 29, 2013 | September 28, 2014
Aerospace | $ | 5,983 |  | $ | 6,409 |  | $ | 1,068 |  | $ | 1,199 |
Combat Systems | 4,241 |  | 4,118 |  | 658 |  | 591 |
Marine Systems | 5,082 |  | 5,272 |  | 507 |  | 510 |
Information Systems and Technology | 7,577 |  | 6,691 |  | 599 |  | 573 |
Corporate* | — |  | — |  | (67 | ) | (51 | )
| $ | 22,883 |  | $ | 22,490 |  | $ | 2,765 |  | $ | 2,822 |

*Corporate operating results consist primarily of stock option expense.
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O. CONDENSED CONSOLIDATING FINANCIAL STATEMENTS
The fixed-rate notes described in Note H are fully and unconditionally guaranteed on an unsecured, joint and several basis by certain of our 100-percent-owned subsidiaries (the guarantors). The following condensed consolidating financial statements illustrate the composition of the parent, the guarantors on a combined basis (each guarantor together with its majority-owned subsidiaries) and all other subsidiaries on a combined basis.
CONDENSED CONSOLIDATING STATEMENTS OF EARNINGS (UNAUDITED)

Three Months Ended September 29, 2013 | Parent | Guarantors on a Combined Basis | Other Subsidiaries on a Combined Basis | Consolidating Adjustments | Total Consolidated
Revenues | $ | — |  | $ | 6,925 |  | $ | 810 |  | $ | — |  | $ | 7,735 |
Cost of sales | 2 |  | 5,629 |  | 646 |  | — |  | 6,277 |
G&A | 19 |  | 410 |  | 68 |  | — |  | 497 |
Operating earnings | (21 | ) | 886 |  | 96 |  | — |  | 961 |
Interest, net | (23 | ) | 1 |  | — |  | — |  | (22 | )
Other, net | 1 |  | — |  | 3 |  | — |  | 4 |
Earnings before income tax | (43 | ) | 887 |  | 99 |  | — |  | 943 |
Provision for income tax, net | (15 | ) | 290 |  | 16 |  | — |  | 291 |
Discontinued operations, net of tax | (1 | ) | — |  | — |  | — |  | (1 | )
Equity in net earnings of subsidiaries | 680 |  | — |  | — |  | (680 | ) | — |
Net earnings | $ | 651 |  | $ | 597 |  | $ | 83 |  | $ | (680 | ) | $ | 651 |
Comprehensive income | $ | 871 |  | $ | 611 |  | $ | 236 |  | $ | (847 | ) | $ | 871 |
Three Months Ended September 28, 2014 |  |  |  |  |
Revenues | $ | — |  | $ | 6,761 |  | $ | 990 |  | $ | — |  | $ | 7,751 |
Cost of sales | (1 | ) | 5,512 |  | 763 |  | — |  | 6,274 |
G&A | 16 |  | 397 |  | 65 |  | — |  | 478 |
Operating earnings | (15 | ) | 852 |  | 162 |  | — |  | 999 |
Interest, net | (21 | ) | (4 | ) | 4 |  | — |  | (21 | )
Other, net | (2 | ) | 2 |  | 1 |  | — |  | 1 |
Earnings before income tax | (38 | ) | 850 |  | 167 |  | — |  | 979 |
Provision for income tax, net | (8 | ) | 268 |  | 25 |  | — |  | 285 |
Discontinued operations, net of tax | 2 |  | — |  | — |  | — |  | 2 |
Equity in net earnings of subsidiaries | 724 |  | — |  | — |  | (724 | ) | — |
Net earnings | $ | 696 |  | $ | 582 |  | $ | 142 |  | $ | (724 | ) | $ | 696 |
Comprehensive income | $ | 463 |  | $ | 570 |  | $ | (120 | ) | $ | (450 | ) | $ | 463 |

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CONDENSED CONSOLIDATING STATEMENTS OF EARNINGS (UNAUDITED)

Nine Months Ended September 29, 2013 | Parent | Guarantors on a Combined Basis | Other Subsidiaries on a Combined Basis | Consolidating Adjustments | Total Consolidated
Revenues | $ | — |  | $ | 20,244 |  | $ | 2,639 |  | $ | — |  | $ | 22,883 |
Cost of sales | 10 |  | 16,454 |  | 2,148 |  | — |  | 18,612 |
G&A | 56 |  | 1,229 |  | 221 |  | — |  | 1,506 |
Operating earnings | (66 | ) | 2,561 |  | 270 |  | — |  | 2,765 |
Interest, net | (69 | ) | 4 |  | 2 |  | — |  | (63 | )
Other, net | — |  | — |  | 4 |  | — |  | 4 |
Earnings before income tax | (135 | ) | 2,565 |  | 276 |  | — |  | 2,706 |
Provision for income tax, net | (35 | ) | 804 |  | 75 |  | — |  | 844 |
Discontinued operations, net of tax | — |  | — |  | — |  | — |  | — |
Equity in net earnings of subsidiaries | 1,962 |  | — |  | — |  | (1,962 | ) | — |
Net earnings | $ | 1,862 |  | $ | 1,761 |  | $ | 201 |  | $ | (1,962 | ) | $ | 1,862 |
Comprehensive income | $ | 1,968 |  | $ | 1,794 |  | $ | 95 |  | $ | (1,889 | ) | $ | 1,968 |
Nine Months Ended September 28, 2014 |  |  |  |  |
Revenues | $ | — |  | $ | 19,592 |  | $ | 2,898 |  | $ | — |  | $ | 22,490 |
Cost of sales | 8 |  | 15,943 |  | 2,262 |  | — |  | 18,213 |
G&A | 44 |  | 1,165 |  | 246 |  | — |  | 1,455 |
Operating earnings | (52 | ) | 2,484 |  | 390 |  | — |  | 2,822 |
Interest, net | (68 | ) | (4 | ) | 5 |  | — |  | (67 | )
Other, net | (4 | ) | 5 |  | 1 |  | — |  | 2 |
Earnings before income tax | (124 | ) | 2,485 |  | 396 |  | — |  | 2,757 |
Provision for income tax, net | (31 | ) | 788 |  | 64 |  | — |  | 821 |
Discontinued operations, net of tax | (104 | ) | — |  | — |  | — |  | (104 | )
Equity in net earnings of subsidiaries | 2,029 |  | — |  | — |  | (2,029 | ) | — |
Net earnings | $ | 1,832 |  | $ | 1,697 |  | $ | 332 |  | $ | (2,029 | ) | $ | 1,832 |
Comprehensive income | $ | 1,680 |  | $ | 1,680 |  | $ | 86 |  | $ | (1,766 | ) | $ | 1,680 |

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CONDENSED CONSOLIDATING BALANCE SHEETS (UNAUDITED)

December 31, 2013 | Parent | Guarantors on a Combined Basis | Other Subsidiaries on a Combined Basis | Consolidating Adjustments | Total Consolidated
ASSETS |  |  |  |  |
Current assets: |  |  |  |  |
Cash and equivalents | $ | 4,179 |  | $ | — |  | $ | 1,122 |  | $ | — |  | $ | 5,301 |
Accounts receivable | — |  | 1,451 |  | 2,919 |  | — |  | 4,370 |
Contracts in process | 571 |  | 3,124 |  | 1,085 |  | — |  | 4,780 |
Inventories |  |  |  |  |
Work in process | — |  | 1,623 |  | 10 |  | — |  | 1,633 |
Raw materials | — |  | 1,172 |  | 38 |  | — |  | 1,210 |
Finished goods | — |  | 24 |  | 5 |  | — |  | 29 |
Pre-owned aircraft | — |  | 18 |  | — |  | — |  | 18 |
Other current assets | 424 |  | 203 |  | 194 |  | — |  | 821 |
Total current assets | 5,174 |  | 7,615 |  | 5,373 |  | — |  | 18,162 |
Noncurrent assets: |  |  |  |  |
Property, plant and equipment | 156 |  | 5,827 |  | 1,169 |  | — |  | 7,152 |
Accumulated depreciation of PP&E | (64 | ) | (3,062 | ) | (667 | ) | — |  | (3,793 | )
Intangible assets | — |  | 1,614 |  | 968 |  | — |  | 2,582 |
Accumulated amortization of intangible assets | — |  | (1,111 | ) | (427 | ) | — |  | (1,538 | )
Goodwill | — |  | 8,041 |  | 3,891 |  | — |  | 11,932 |
Other assets | 600 |  | 483 |  | 398 |  | (484 | ) | 997 |
Investment in subsidiaries | 35,071 |  | — |  | — |  | (35,071 | ) | — |
Total noncurrent assets | 35,763 |  | 11,792 |  | 5,332 |  | (35,555 | ) | 17,332 |
Total assets | $ | 40,937 |  | $ | 19,407 |  | $ | 10,705 |  | $ | (35,555 | ) | $ | 35,494 |
LIABILITIES AND SHAREHOLDERS' EQUITY |  |  |  |  |
Current liabilities: |  |  |  |  |
Customer advances and deposits | $ | — |  | $ | 3,493 |  | $ | 3,091 |  | $ | — |  | $ | 6,584 |
Other current liabilities | 868 |  | 3,644 |  | 1,163 |  | — |  | 5,675 |
Total current liabilities | 868 |  | 7,137 |  | 4,254 |  | — |  | 12,259 |
Noncurrent liabilities: |  |  |  |  |
Long-term debt | 3,883 |  | 25 |  | — |  | — |  | 3,908 |
Other liabilities | 2,333 |  | 2,007 |  | 486 |  | — |  | 4,826 |
Total noncurrent liabilities | 6,216 |  | 2,032 |  | 486 |  | — |  | 8,734 |
Intercompany | 19,352 |  | (19,697 | ) | 345 |  | — |  | — |
Shareholders' equity: |  |  |  |  |
Common stock | 482 |  | 6 |  | 3,570 |  | (3,576 | ) | 482 |
Other shareholders' equity | 14,019 |  | 29,929 |  | 2,050 |  | (31,979 | ) | 14,019 |
Total shareholders' equity | 14,501 |  | 29,935 |  | 5,620 |  | (35,555 | ) | 14,501 |
Total liabilities and shareholders' equity | $ | 40,937 |  | $ | 19,407 |  | $ | 10,705 |  | $ | (35,555 | ) | $ | 35,494 |

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CONDENSED CONSOLIDATING BALANCE SHEETS (UNAUDITED)

September 28, 2014 | Parent | Guarantors on a Combined Basis | Other Subsidiaries on a Combined Basis | Consolidating Adjustments | Total Consolidated
ASSETS |  |  |  |  |
Current assets: |  |  |  |  |
Cash and equivalents | $ | 2,257 |  | $ | — |  | $ | 2,848 |  | $ | — |  | $ | 5,105 |
Accounts receivable | — |  | 1,404 |  | 2,777 |  | — |  | 4,181 |
Contracts in process | 516 |  | 2,911 |  | 1,009 |  | — |  | 4,436 |
Inventories |  |  |  |  |
Work in process | — |  | 1,832 |  | 11 |  | — |  | 1,843 |
Raw materials | — |  | 1,212 |  | 32 |  | — |  | 1,244 |
Finished goods | — |  | 15 |  | 8 |  | — |  | 23 |
Pre-owned aircraft | — |  | 29 |  | — |  | — |  | 29 |
Other current assets | 753 |  | 394 |  | 161 |  | — |  | 1,308 |
Total current assets | 3,526 |  | 7,797 |  | 6,846 |  | — |  | 18,169 |
Noncurrent assets: |  |  |  |  |
Property, plant and equipment | 209 |  | 5,947 |  | 1,151 |  | — |  | 7,307 |
Accumulated depreciation of PP&E | (69 | ) | (3,228 | ) | (688 | ) | — |  | (3,985 | )
Intangible assets | — |  | 1,452 |  | 945 |  | — |  | 2,397 |
Accumulated amortization of intangible assets | — |  | (1,019 | ) | (449 | ) | — |  | (1,468 | )
Goodwill | — |  | 7,991 |  | 3,765 |  | — |  | 11,756 |
Other assets | 474 |  | 400 |  | 337 |  | (76 | ) | 1,135 |
Investment in subsidiaries | 37,270 |  | — |  | — |  | (37,270 | ) | — |
Total noncurrent assets | 37,884 |  | 11,543 |  | 5,061 |  | (37,346 | ) | 17,142 |
Total assets | $ | 41,410 |  | $ | 19,340 |  | $ | 11,907 |  | $ | (37,346 | ) | $ | 35,311 |
LIABILITIES AND SHAREHOLDERS' EQUITY |  |  |  |  |
Current liabilities: |  |  |  |  |
Short-term debt | $ | 500 |  | $ | 1 |  | $ | — |  | $ | — |  | $ | 501 |
Customer advances and deposits | — |  | 3,614 |  | 4,376 |  | — |  | 7,990 |
Other current liabilities | 1,268 |  | 3,664 |  | 1,247 |  | — |  | 6,179 |
Total current liabilities | 1,768 |  | 7,279 |  | 5,623 |  | — |  | 14,670 |
Noncurrent liabilities: |  |  |  |  |
Long-term debt | 3,386 |  | 24 |  | — |  | — |  | 3,410 |
Other liabilities | 1,797 |  | 1,988 |  | 436 |  | — |  | 4,221 |
Total noncurrent liabilities | 5,183 |  | 2,012 |  | 436 |  | — |  | 7,631 |
Intercompany | 21,449 |  | (21,573 | ) | 124 |  | — |  | — |
Shareholders' equity: |  |  |  |  |
Common stock | 482 |  | 6 |  | 2,043 |  | (2,049 | ) | 482 |
Other shareholders' equity | 12,528 |  | 31,616 |  | 3,681 |  | (35,297 | ) | 12,528 |
Total shareholders' equity | 13,010 |  | 31,622 |  | 5,724 |  | (37,346 | ) | 13,010 |
Total liabilities and shareholders' equity | $ | 41,410 |  | $ | 19,340 |  | $ | 11,907 |  | $ | (37,346 | ) | $ | 35,311 |

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CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS (UNAUDITED)

Nine Months Ended September 29, 2013 | Parent | Guarantors on a Combined Basis | Other Subsidiaries on a Combined Basis | Consolidating Adjustments | Total Consolidated
Net cash provided by operating activities * | $ | (445 | ) | $ | 1,983 |  | $ | 15 |  | $ | — |  | $ | 1,553 |
Net cash used by investing activities * | 1 |  | (188 | ) | (25 | ) | — |  | (212 | )
Cash flows from financing activities: |  |  |  |  |
Purchases of common stock | (696 | ) | — |  | — |  | — |  | (696 | )
Proceeds from option exercises | 484 |  | — |  | — |  | — |  | 484 |
Dividends paid | (394 | ) | — |  | — |  | — |  | (394 | )
Other, net | 19 |  | — |  | 27 |  | — |  | 46 |
Net cash used by financing activities * | (587 | ) | — |  | 27 |  | — |  | (560 | )
Net cash used by discontinued operations | (12 | ) | — |  | — |  | — |  | (12 | )
Cash sweep/funding by parent | 1,801 |  | (1,795 | ) | (6 | ) | — |  | — |
Net increase in cash and equivalents | 758 |  | — |  | 11 |  | — |  | 769 |
Cash and equivalents at beginning of period | 2,300 |  | — |  | 996 |  | — |  | 3,296 |
Cash and equivalents at end of period | $ | 3,058 |  | $ | — |  | $ | 1,007 |  | $ | — |  | $ | 4,065 |
Nine Months Ended September 28, 2014 |  |  |  |  |
Net cash provided by operating activities * | $ | (237 | ) | $ | 2,140 |  | $ | 1,895 |  | $ | — |  | $ | 3,798 |
Cash flows from investing activities: |  |  |  |  |
Purchases of held-to-maturity securities | (500 | ) | — |  | — |  | — |  | (500 | )
Capital expenditures | (54 | ) | (257 | ) | (26 | ) | — |  | (337 | )
Other, net | 2 |  | 19 |  | (10 | ) | — |  | 11 |
Net cash used by investing activities * | (552 | ) | (238 | ) | (36 | ) | — |  | (826 | )
Cash flows from financing activities: |  |  |  |  |
Purchases of common stock | (3,117 | ) | — |  | — |  | — |  | (3,117 | )
Dividends paid | (618 | ) | — |  | — |  | — |  | (618 | )
Proceeds from option exercises | 475 |  | — |  | — |  | — |  | 475 |
Other, net | 66 |  | — |  | — |  | — |  | 66 |
Net cash used by financing activities * | (3,194 | ) | — |  | — |  | — |  | (3,194 | )
Net cash provided by discontinued operations | 26 |  | — |  | — |  | — |  | 26 |
Cash sweep/funding by parent | 2,035 |  | (1,902 | ) | (133 | ) | — |  | — |
Net decrease in cash and equivalents | (1,922 | ) | — |  | 1,726 |  | — |  | (196 | )
Cash and equivalents at beginning of period | 4,179 |  | — |  | 1,122 |  | — |  | 5,301 |
Cash and equivalents at end of period | $ | 2,257 |  | $ | — |  | $ | 2,848 |  | $ | — |  | $ | 5,105 |

* Continuing operations only
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(Dollars in millions, except per-share amounts or unless otherwise noted)
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS OVERVIEW
General Dynamics is an aerospace and defense company that offers a broad portfolio of products and services in business aviation; combat vehicles, weapons systems and munitions; shipbuilding; and communication and information technology systems and solutions. We operate globally through four business groups: Aerospace, Combat Systems, Marine Systems and Information Systems and Technology. Our primary customers are the U.S. government, including the Department of Defense, intelligence community and other U.S. government customers; international governments; and a wide range of corporate and individual customers for business jets. The following discussion should be read in conjunction with our 2013 Annual Report on Form 10-K and with the unaudited Consolidated Financial Statements included in this Form 10-Q. The unaudited Consolidated Financial Statements have been restated to reflect the results of operations of our axle business in discontinued operations (for further discussion, see Note A to the unaudited Consolidated Financial Statements).
DEFENSE BUSINESS ENVIRONMENT
With approximately 60 percent of our revenues from the U.S. government, our financial performance is impacted by U.S. government spending levels, particularly defense spending. When the U.S. government's new fiscal year began on October 1, 2014, the President's fiscal year (FY) 2015 budget request had not been approved by the Congress. Subsequently, a continuing resolution (CR), which prescribes defense funding at prior-year levels, was approved through December 11, 2014. Since the FY15 budget request is relatively consistent with the FY14 appropriation and our backlog supports our expected revenues, we do not expect that the CR will have a material impact on our operating results during the fourth quarter of 2014.
RESULTS OF OPERATIONS
INTRODUCTION
An understanding of our accounting practices is important in the evaluation of our operating results. We recognize the majority of our revenues using the percentage-of-completion method of accounting. The following paragraphs explain how this method is applied in recognizing revenues and operating costs in our Aerospace and defense groups.
In the Aerospace group, contracts for new aircraft have two major phases: the manufacture of the “green” aircraft and the aircraft’s outfitting, which includes exterior painting and installation of customer-selected interiors. We record revenues on these contracts at the completion of these two phases: when green aircraft are delivered to and accepted by the customer, and when the customer accepts final delivery of the outfitted aircraft. Revenues associated with the group’s completions of other original equipment manufacturers' (OEMs) aircraft and the group's services businesses are recognized as work progresses or upon delivery of services. Fluctuations in revenues from period to period result from the number and mix of new aircraft deliveries (green and outfitted), progress on aircraft completions and the level of aircraft service activity during the period.
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The majority of the Aerospace group’s operating costs relates to new aircraft production for firm orders and consists of labor, material, subcontractor and overhead costs. The costs are accumulated in production lots and recognized as operating costs at green aircraft delivery based on the estimated average unit cost in a production lot. While changes in the estimated average unit cost for a production lot impact the level of operating costs, the amount of operating costs reported in a given period is based largely on the number and type of aircraft delivered. Operating costs in the Aerospace group’s completions and services businesses are generally recognized as incurred.
For new aircraft, operating earnings and margins are a function of the prices of our aircraft, our operational efficiency in manufacturing and outfitting the aircraft, and the mix of aircraft deliveries between the higher-margin large-cabin and lower-margin mid-cabin aircraft. Additional factors affecting the group’s earnings and margins include the volume, mix and profitability of completions and services work performed, the market for pre-owned aircraft, and the level of general and administrative (G&A) and net research and development (R&D) costs incurred by the group.
In the defense groups, revenue on long-term government contracts is recognized as work progresses, either as products are produced or services are rendered. As a result, variations in revenues are discussed generally in terms of volume, typically measured by the level of activity on individual contracts or programs. Year-over-year variances attributed to volume are due to changes in production or service levels and delivery schedules.
Operating costs for the defense groups consist of labor, material, subcontractor, overhead and G&A costs and are recognized generally as incurred. Variances in costs recognized from period to period primarily reflect increases and decreases in production or activity levels on individual contracts and, therefore, result largely from the same factors that drive variances in revenues.
Operating earnings and margins in the defense groups are driven by changes in volume, performance or contract mix. Performance refers to changes in profitability based on revisions to estimates at completion on individual contracts. These revisions result from increases or decreases to the estimated value of the contract, the estimated costs to complete or both. Therefore, changes in costs incurred in the period compared with prior periods do not necessarily impact profitability. It is only when total estimated costs at completion on a given contract change without a corresponding change in the value of that contract that the profitability of that contract may be impacted. Contract mix refers to changes in the volume of higher- vs. lower-margin work. Additionally, higher or lower margins can be inherent in the contract type (e.g., fixed-price/cost-reimbursable) or type of work (e.g., development/production).
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CONSOLIDATED OVERVIEW

Three Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 7,735 |  |  | $ | 7,751 |  |  | $ | 16 |  |  | 0.2 | %
Operating costs and expenses | 6,774 |  |  | 6,752 |  |  | 22 |  |  | 0.3 | %
Operating earnings | 961 |  |  | 999 |  |  | 38 |  |  | 4.0 | %
Operating margins | 12.4 | % |  | 12.9 | % |  |  |  |
Nine Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 22,883 |  |  | $ | 22,490 |  |  | $ | (393 | ) |  | (1.7 | )%
Operating costs and expenses | 20,118 |  |  | 19,668 |  |  | 450 |  |  | 2.2 | %
Operating earnings | 2,765 |  |  | 2,822 |  |  | 57 |  |  | 2.1 | %
Operating margins | 12.1 | % |  | 12.5 | % |  |  |  |

Our revenues increased in the third quarter of 2014 compared with the prior-year period due to higher revenues in our Aerospace, Combat Systems and Marine Systems groups from increased aircraft deliveries, the start of an international vehicle program and higher ship construction activity, respectively. These increases were partially offset by lower volume in our Information Systems and Technology group, primarily associated with several mobile communication systems programs. Revenues were lower in the first nine months of 2014 compared with the prior-year period. Decreased U.S. Army spending negatively affected our Combat Systems and Information Systems and Technology groups, though to a lesser degree than expected in the Information Systems and Technology group. Aerospace and Marine Systems revenues grew year over year through the first nine months of 2014 due to the factors described above.
Operating costs and expenses decreased, and operating earnings were up in 2014, resulting in an increase in operating margins of 50 basis points in the third quarter and 40 basis points in the first nine months of 2014 compared with the prior-year periods. The increased margins in 2014 were due to improved performance in aircraft manufacturing and outfitting activities in the Aerospace group and significant cost reductions in the Information Systems and Technology group. Third quarter operating margins of 12.9 percent were the highest quarterly margins the company has generated in six years.
REVIEW OF BUSINESS GROUPS
Following is a discussion of operating results and outlook for each of our business groups. For the Aerospace group, results are analyzed for specific lines of products and services, consistent with how the group is managed. For the defense groups, the discussion is based on the types of products and services each group offers with a supplemental discussion of specific contracts and programs when significant to the groups’ results. Information regarding our business groups also can be found in Note N to the unaudited Consolidated Financial Statements.
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AEROSPACE

Three Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 2,152 |  |  | $ | 2,289 |  |  | $ | 137 |  |  | 6.4 | %
Operating earnings | 369 |  |  | 411 |  |  | 42 |  |  | 11.4 | %
Operating margin | 17.1 | % |  | 18.0 | % |  |  |  |
Gulfstream aircraft deliveries (in units): |  |  |  |  |  |  |
Green | 34 |  | 38 |  | 4 |  |  | 11.8 | %
Outfitted | 38 |  | 31 |  | (7 | ) |  | (18.4 | )%
Nine Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 5,983 |  |  | $ | 6,409 |  |  | $ | 426 |  |  | 7.1 | %
Operating earnings | 1,068 |  |  | 1,199 |  |  | 131 |  |  | 12.3 | %
Operating margin | 17.9 | % |  | 18.7 | % |  |  |  |
Gulfstream aircraft deliveries (in units): |  |  |  |  |  |  |
Green | 99 |  |  | 106 |  |  | 7 |  |  | 7.1 | %
Outfitted | 103 |  |  | 108 |  |  | 5 |  |  | 4.9 | %

Operating Results
The increase in the Aerospace group's revenues in the third quarter and first nine months of 2014 compared with the prior-year periods consisted of the following:

| Third Quarter |  | Nine Months
Aircraft manufacturing, outfitting and completions | $ | 175 |  |  | $ | 474 |
Pre-owned aircraft | (27 | ) |  | (110 | )
Aircraft services | (11 | ) |  | 62 |
Total increase | $ | 137 |  |  | $ | 426 |

Aircraft manufacturing, outfitting and completions revenues increased in 2014 primarily due to additional deliveries of large-cabin aircraft. We have experienced reduced aircraft trade-in activity in 2014 leading to lower pre-owned aircraft sales. We had three sales in the third quarter and first nine months of 2014 compared to four sales in the third quarter and nine in the first nine months of 2013. Although aircraft services activity was slightly lower in the third quarter of 2014 compared to the third quarter of 2013, revenues in the first nine months of 2014 exceeded the prior-year period due to growth in the number of aircraft in service and the resulting increased demand for maintenance work.
The increase in the group's operating earnings in the third quarter and first nine months of 2014 compared with the prior-year periods consisted of the following:
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| Third Quarter |  | Nine Months
Aircraft manufacturing, outfitting and completions | $ | 39 |  |  | $ | 179 |
Pre-owned aircraft | (1 | ) |  | 3 |
Aircraft services | 9 |  |  | 13 |
G&A/R&D/other expenses | (5 | ) |  | (64 | )
Total increase | $ | 42 |  |  | $ | 131 |

Aircraft manufacturing, outfitting and completions earnings grew in the third quarter and first nine months of 2014 due to improved operating performance on our large- and mid-cabin aircraft production. Partially offsetting these increases were higher net R&D expenses associated with ongoing product-development efforts. Overall, the Aerospace group's operating margins increased 90 basis points in the third quarter and 80 basis points in the first nine months of 2014 compared with the prior-year periods primarily due to additional higher-margin aircraft deliveries and favorable cost performance in manufacturing and outfitting activities.
Outlook
We expect an increase of approximately 8 percent in the group's full-year revenues in 2014 compared with 2013 as a result of increased deliveries of Gulfstream aircraft. Operating margins are expected to be in the mid-18 percent range.
COMBAT SYSTEMS

Three Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 1,306 |  |  | $ | 1,395 |  |  | $ | 89 |  |  | 6.8 | %
Operating earnings | 228 |  |  | 232 |  |  | 4 |  |  | 1.8 | %
Operating margins | 17.5 | % |  | 16.6 | % |  |  |  |
Nine Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 4,241 |  |  | $ | 4,118 |  |  | $ | (123 | ) |  | (2.9 | )%
Operating earnings | 658 |  |  | 591 |  |  | (67 | ) |  | (10.2 | )%
Operating margins | 15.5 | % |  | 14.4 | % |  |  |  |

Operating Results
The Combat Systems group's revenues were up in the third quarter, but down somewhat in the first nine months of 2014 compared with the prior-year periods. The changes consisted of the following:

| Third Quarter |  | Nine Months
U.S. military vehicles | $ | (143 | ) |  | $ | (466 | )
Weapon systems and munitions | 6 |  |  | (57 | )
International military vehicles | 226 |  |  | 400 |
Total increase (decrease) | $ | 89 |  |  | $ | (123 | )

U.S. military vehicle revenues were down in the third quarter and first nine months of 2014 as a result of the anticipated decrease in U.S. Army spending, which impacted our major U.S. ground forces programs, including Stryker, Abrams, Buffalo and Mine Resistant, Ambush Protected (MRAP) vehicles. Revenues also decreased on the completed Ground Combat Vehicle (GCV) design and development
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program. While weapons systems and munitions revenues increased slightly in the third quarter of 2014 compared with the prior-year period, revenues decreased in the first nine months of 2014 primarily due to lower tank ammunition production for international customers.
Revenues for international military vehicles were up significantly in the third quarter and first nine months of 2014 as work commenced on a $10 billion international order received in the first quarter of 2014. Work on this order was somewhat offset by lower revenues on several other international contracts that are nearing completion.
The Combat Systems group's operating margins decreased 90 basis points in the third quarter and 110 basis points in the first nine months of 2014 compared with the prior-year periods primarily due to mix shift in 2014 from older, more mature programs nearing completion to new programs. Somewhat offsetting this shift in contract mix, operating margins were up in our European and weapons systems businesses as a result of reduced overhead costs following restructuring activities in 2013 and the first quarter of 2014.
Outlook
We expect the Combat Systems group’s full-year revenues in 2014 to be about $5.7 billion, with operating margins around 15 percent as international work offsets the majority of scheduled declines in U.S. military production.
MARINE SYSTEMS

Three Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 1,697 |  |  | $ | 1,820 |  |  | $ | 123 |  |  | 7.2 | %
Operating earnings | 170 |  |  | 170 |  |  | — |  |  | — | %
Operating margins | 10.0 | % |  | 9.3 | % |  |  |  |
Nine Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 5,082 |  |  | $ | 5,272 |  |  | $ | 190 |  |  | 3.7 | %
Operating earnings | 507 |  |  | 510 |  |  | 3 |  |  | 0.6 | %
Operating margins | 10.0 | % |  | 9.7 | % |  |  |  |

Operating Results
The increase in the Marine Systems group’s revenues in the third quarter and first nine months of 2014 compared with the prior-year periods consisted of the following:

| Third Quarter |  | Nine Months
Navy ship construction | $ | 77 |  |  | $ | 231 |
Navy engineering, repair and other services | 4 |  |  | (160 | )
Commercial ship construction | 42 |  |  | 119 |
Total increase | $ | 123 |  |  | $ | 190 |

The group’s U.S. Navy ship construction programs include Virginia-class submarines, DDG-1000 and DDG-51 destroyers, and Mobile Landing Platform (MLP) auxiliary support ships. The increase in construction revenues in 2014 is primarily due to higher volume on the Virginia-class program, including long-lead materials for the Block IV contract, which was awarded in the second quarter of 2014. This
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increase was partially offset by lower volume on the MLP program, as two ships have been delivered and work ramps up on the third and fourth ships.
Although revenues for Navy engineering, repair and other services were slightly higher in the third quarter of 2014 compared to the third quarter of 2013, revenues in the first nine months of 2014 decreased primarily due to lower spending by the Navy on submarine-related overhaul and repair services.
Commercial ship construction revenues increased in the third quarter and first nine months of 2014 as work ramped up on the group's construction of Jones Act ships. The group currently has 10 of these ships under contract.
Operating margins decreased 70 basis points in the third quarter and 30 basis points in first nine months of 2014 compared with the prior-year periods primarily due to a shift in contract mix as work on the new Virginia-class contract ramped up and volume decreased on mature, higher-margin contracts, including MLP.
Outlook
We expect the Marine Systems group’s 2014 full-year revenues to increase about 7 percent from 2013 with operating margins in the mid- to high-9 percent range.
INFORMATION SYSTEMS AND TECHNOLOGY

Three Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 2,580 |  |  | $ | 2,247 |  |  | $ | (333 | ) |  | (12.9 | )%
Operating earnings | 216 |  |  | 202 |  |  | (14 | ) |  | (6.5 | )%
Operating margins | 8.4 | % |  | 9.0 | % |  |  |  |
Nine Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 7,577 |  |  | $ | 6,691 |  |  | $ | (886 | ) |  | (11.7 | )%
Operating earnings | 599 |  |  | 573 |  |  | (26 | ) |  | (4.3 | )%
Operating margins | 7.9 | % |  | 8.6 | % |  |  |  |

Operating Results
The Information Systems and Technology group's revenues in the third quarter and first nine months of 2014 were higher than our expectations, though down from the prior-year periods. The decrease from 2013 consisted of the following:

| Third Quarter |  | Nine Months
Mobile communication systems | $ | (239 | ) |  | $ | (650 | )
Information technology (IT) solutions and mission support services | (80 | ) |  | (173 | )
Intelligence, surveillance and reconnaissance (ISR) systems | (14 | ) |  | (63 | )
Total decrease | $ | (333 | ) |  | $ | (886 | )

Revenues decreased approximately 25 percent in the mobile communication systems business in the third quarter and first nine months of 2014 primarily as a result of decreased U.S. Army spending on several programs, including the Joint Tactical Radio System (JTRS) Handheld, Manpack and Small Form Fit (HMS), Warfighter Information Network-Tactical (WIN-T) and Common Hardware Systems-4 (CHS-4) programs. Revenues decreased in both periods of 2014 in our IT services business due to lower volume on
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several programs, including our commercial wireless work. This decrease was partially offset by our work on a contract to provide contact-center services for the Centers for Medicare & Medicaid Services. Revenues decreased in 2014 across the ISR business, particularly on several cyber security programs, driven by lower U.S. government spending.
The group's operating margins increased 60 basis points in the third quarter and 70 basis points in the first nine months of 2014 compared with the prior-year periods, the result of solid operating performance across our lines of business and the favorable impact of ongoing cost-reduction efforts. In the third quarter of 2014, we announced the consolidation of our mobile communication systems and ISR systems businesses into a new combined business unit, General Dynamics Mission Systems. The consolidation, effective in January 2015, will leverage their complementary capabilities and provide further opportunities to enhance operating performance across the group.
Outlook
We expect 2014 full-year revenues in the Information Systems and Technology group to be approximately $9 billion, down 12 percent from 2013 largely due to slowed defense spending on major production programs in the mobile communication systems business discussed above. Operating margins are expected to be in the mid-8 percent range.
CORPORATE
Corporate results consist primarily of compensation expense for stock options. Corporate costs totaled $22 in the third quarter of 2013 compared with $16 in the third quarter of 2014, and $67 in the first nine months of 2013 compared with $51 in the 2014 period. We expect 2014 full-year Corporate costs of $70 to $75.
OTHER INFORMATION
PRODUCT REVENUES AND OPERATING COSTS

Three Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 4,752 |  |  | $ | 4,909 |  |  | $ | 157 |  |  | 3.3 | %
Operating costs | 3,700 |  |  | 3,866 |  |  | 166 |  |  | 4.5 | %
Nine Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 13,981 |  |  | $ | 14,005 |  |  | $ | 24 |  |  | 0.2 | %
Operating costs | 10,979 |  |  | 10,967 |  |  | (12 | ) |  | (0.1 | )%

The increase in product revenues in the third quarter and first nine months of 2014 compared with the prior-year periods consisted of the following:
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| Third Quarter |  | Nine Months
Aircraft manufacturing and outfitting | $ | 191 |  |  | $ | 482 |
Navy ship construction | 51 |  |  | 156 |
Mobile communication products | (199 | ) |  | (454 | )
Military vehicle production | 132 |  |  | (65 | )
Pre-owned aircraft | (27 | ) |  | (110 | )
Other, net | 9 |  |  | 15 |
Total increase | $ | 157 |  |  | $ | 24 |

Aircraft manufacturing and outfitting revenues increased in 2014 due to additional deliveries of large-cabin aircraft. Navy construction revenues increased primarily due to higher volume on the Virginia-class submarine program. Offsetting these increases, lower U.S. Army spending negatively impacted revenues on several mobile communication products and military vehicle production programs. However, military vehicle production revenues increased in the third quarter of 2014 compared to the prior-year period as activity ramped up on a significant international vehicle order received in the first quarter of 2014. Pre-owned aircraft sales were down as there have been fewer aircraft trade-ins and resulting sales in 2014 than the comparable 2013 periods.
Product operating costs were higher in the third quarter, but lower in the first nine months of 2014 compared with the prior-year periods. While the majority of the change in product operating costs was due to volume, costs in the first nine months of 2014 were affected by other changes, including higher net R&D expenses in the Aerospace group associated with ongoing product-development efforts.

| Third Quarter |  | Nine Months
Changes due to volume: |  |  |
Aircraft manufacturing and outfitting | $ | 129 |  |  | $ | 267 |
Navy ship construction | 36 |  |  | 105 |
Mobile communication products | (170 | ) |  | (401 | )
Military vehicle production | 159 |  |  | 35 |
Pre-owned aircraft | (26 | ) |  | (113 | )
Other, net | (4 | ) |  | (28 | )
| 124 |  |  | (135 | )
Other changes, net | 42 |  |  | 123 |
Total increase (decrease) | $ | 166 |  |  | $ | (12 | )

SERVICE REVENUES AND OPERATING COSTS

Three Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 2,983 |  |  | $ | 2,842 |  |  | $ | (141 | ) |  | (4.7 | )%
Operating costs | 2,577 |  |  | 2,408 |  |  | (169 | ) |  | (6.6 | )%
Nine Months Ended | September 29, 2013 |  | September 28, 2014 |  | Variance
Revenues | $ | 8,902 |  |  | $ | 8,485 |  |  | $ | (417 | ) |  | (4.7 | )%
Operating costs | 7,633 |  |  | 7,246 |  |  | (387 | ) |  | (5.1 | )%

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The decrease in service revenues in the third quarter and first nine months of 2014 compared with the prior-year periods consisted of the following:

| Third Quarter |  | Nine Months
Mobile communication support | $ | (25 | ) |  | $ | (128 | )
IT services | (55 | ) |  | (121 | )
Navy engineering, repair and other services | 29 |  |  | (85 | )
Military vehicle services | (63 | ) |  | (69 | )
Other, net | (27 | ) |  | (14 | )
Total decrease | $ | (141 | ) |  | $ | (417 | )

Mobile communication support and military vehicle services revenues were lower due to decreased U.S. Army spending. IT services revenues decreased due to reduced commercial wireless work. Although Navy engineering, repair and other services revenues were slightly higher in the third quarter of 2014 compared to the third quarter of 2013, revenues decreased in the first nine months of 2014 due to lower volume on various submarine programs.
Service operating costs were lower in the third quarter and first nine months of 2014 compared with the prior-year periods. As shown below, the decrease in service operating costs was primarily due to lower volume. No other changes were individually significant.

| Third Quarter |  | Nine Months
Changes due to volume: |  |  |
Mobile communication support | $ | (50 | ) |  | $ | (142 | )
IT services | (48 | ) |  | (75 | )
Navy engineering, repair and other services | 37 |  |  | (51 | )
Military vehicle services | (58 | ) |  | (50 | )
Other, net | (35 | ) |  | (30 | )
| (154 | ) |  | (348 | )
Other changes, net | (15 | ) |  | (39 | )
Total decrease | $ | (169 | ) |  | $ | (387 | )

OTHER INFORMATION
G&A Expenses
As a percentage of revenues, G&A expenses were 6.5 percent in the first nine months of 2014 and 6.6 percent in the same period of 2013. We expect G&A expenses in 2014 to be approximately 6.5 percent of revenues.
Interest, Net
Net interest expense in the first nine months of 2014 was $67 compared with $63 in the same period in 2013. We expect full-year 2014 net interest expense to be approximately $90.
Effective Tax Rate
Our effective tax rate for the first nine months of 2014 was 29.8 percent, compared with 31.2 percent in the prior-year period. The decrease in the effective tax rate in 2014 was primarily due to increased income
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from international operations in jurisdictions with lower tax rates. We anticipate a full-year effective tax rate of approximately 30 percent in 2014.
Discontinued Operations, Net of Tax
In June 2014, we committed to a plan to sell our axle business in the Combat Systems group. Accordingly, the results of operations of this business are reported in discontinued operations. The first nine months of 2014 include an after-tax loss of $106 to write down the net assets of the business to estimated fair value. For further discussion, see Note A to the unaudited Consolidated Financial Statements.
BACKLOG AND ESTIMATED POTENTIAL CONTRACT VALUE
Our total backlog, including funded and unfunded portions, was the highest in company history at $74.4 billion at the end of the third quarter of 2014, up nearly 5 percent from $71.1 billion at the end of the second quarter and more than 55 percent higher than a year ago. Our backlog does not include work awarded on unfunded indefinite delivery, indefinite quantity (IDIQ) contracts or unexercised options associated with existing firm contracts, which we refer to collectively as estimated potential contract value. At the end of the third quarter of 2014, estimated potential contract value was $26.7 billion. Combined, our total estimated contract value was $101.1 billion on September 28, 2014, also the highest level in company history.
The following table details the backlog and the estimated potential contract value of each business group at the end of the second and third quarters of 2014:

| Funded |  | Unfunded |  | Total Backlog |  | Estimated Potential Contract Value |  | Total Estimated Contract Value
| June 29, 2014
Aerospace | $ | 12,556 |  |  | $ | 172 |  |  | $ | 12,728 |  |  | $ | 1,920 |  |  | $ | 14,648 |
Combat Systems | 15,363 |  |  | 852 |  |  | 16,215 |  |  | 8,074 |  |  | 24,289 |
Marine Systems | 15,458 |  |  | 17,747 |  |  | 33,205 |  |  | 1,938 |  |  | 35,143 |
Information Systems and Technology | 7,343 |  |  | 1,602 |  |  | 8,945 |  |  | 16,477 |  |  | 25,422 |
Total | $ | 50,720 |  |  | $ | 20,373 |  |  | $ | 71,093 |  |  | $ | 28,409 |  |  | $ | 99,502 |
| September 28, 2014
Aerospace | $ | 11,924 |  |  | $ | 143 |  |  | $ | 12,067 |  |  | $ | 1,857 |  |  | $ | 13,924 |
Combat Systems | 20,879 |  |  | 732 |  |  | 21,611 |  |  | 5,760 |  |  | 27,371 |
Marine Systems | 14,308 |  |  | 17,574 |  |  | 31,882 |  |  | 2,524 |  |  | 34,406 |
Information Systems and Technology | 7,421 |  |  | 1,452 |  |  | 8,873 |  |  | 16,520 |  |  | 25,393 |
Total | $ | 54,532 |  |  | $ | 19,901 |  |  | $ | 74,433 |  |  | $ | 26,661 |  |  | $ | 101,094 |

AEROSPACE
Aerospace funded backlog represents aircraft orders for which we have definitive purchase contracts and deposits from customers. Unfunded backlog consists of agreements to provide future aircraft maintenance and support services. Estimated potential contract value represents primarily options to purchase new aircraft and long-term agreements with fleet customers.
The group ended the third quarter of 2014 with $12.1 billion of backlog, compared with $12.7 billion at the end of the second quarter. The group experienced strong demand in the quarter with order activity across its product portfolio.
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In October 2014, we introduced an all-new family of business jets, the G500 and G600 aircraft, designed to optimize speed, cabin comfort and efficiency and introduce industry-leading safety technologies. The aircraft are expected to enter into service in early 2018 and early 2019, respectively, following type certification from the U.S. Federal Aviation Administration and European Aviation Safety Agency. Orders associated with these aircraft will be included in our backlog starting in the fourth quarter.
DEFENSE GROUPS
The total backlog in our defense groups 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. While there is no guarantee that future budgets and appropriations will provide funding for a given program, we have included in total backlog only firm contracts at the amounts we believe are likely to receive funding. Total backlog in our defense groups was $62.4 billion on September 28, 2014, up 7 percent from $58.4 billion on June 29, 2014, primarily due to the SCOUT Specialist Vehicle (SV) award detailed below. Estimated potential contract value was $24.8 billion on September 28, 2014. Each of our defense groups received notable contract awards during the quarter.
Combat Systems awards included the following:

• | $5.9 billion from the U.K. Ministry of Defence to deliver SCOUT SV platforms to the British Army between 2017 and 2024. (A portion of this amount was previously reported as an unexercised option.)

• | $75 from the U.S. Army for Hydra-70 rockets.

• | $60 from the U.S. Marine Corps for egress upgrade kits for the Cougar vehicle in support of the MRAP program.

• | $60 from the Peruvian Ministry of Defence for light armored vehicles.

Marine Systems awards included the following:

• | $175 from the U.S. Navy to provide planning yard work, engineering and technical support for nuclear submarines.

• | $140 from the Navy for maintenance and overhaul services on USS Pearl Harbor.

• | $60 from the Navy for Advanced Nuclear Plant Studies in support of development for the next-generation ballistic-missile submarine.

Information Systems and Technology awards included the following:

• | $165 from the Army for ruggedized computing equipment under the CHS-4 program.

• | $80 from the Army under the Warfighter Field Operations Customer Support (FOCUS) program to provide support for live and virtual operations.

• | $50 from the Army to provide logistics services to support information technology transport management.

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• | $50 from the U.S. Department of State to provide supply chain management services.

• | An IDIQ contract from the Navy for its next-generation tactical afloat network, designed to streamline and update shipboard networks. The program has a maximum potential value of $2.5 billion over eight years among five awardees.

• | An IDIQ contract from the Commonwealth of Massachusetts to develop, implement and operate the Massachusetts Next Generation (NG9-1-1) emergency communications system. The program has a maximum potential value of $140 over five years.

FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
We ended the third quarter of 2014 with a cash balance of $5.1 billion, compared with $5.3 billion at the end of 2013. Our net cash position, defined as cash and equivalents and marketable securities less debt, was $1.7 billion at the end of the third quarter of 2014, up from $1.4 billion at the end of 2013. The following is a discussion of our major operating, investing and financing activities, as classified on the unaudited Consolidated Statements of Cash Flows, in the first nine months of 2013 and 2014.
OPERATING ACTIVITIES
We generated cash from operating activities of $3.8 billion in the first nine months of 2014, compared with $1.6 billion in the same period in 2013. The primary driver of cash flows in both periods was net earnings. Additionally, cash flows in the first nine months of 2014 include significant customer deposits received in the third quarter related to a large international contract awarded earlier in 2014 in our Combat Systems group. These deposits are associated with supplier commitments on the program through the next two years.
INVESTING ACTIVITIES
We used $826 for investing activities in the first nine months of 2014, compared with $212 in the same period in 2013. The increase in 2014 was due to the purchase of $500 of short-term held-to-maturity securities in the third quarter of 2014. The other significant use of cash for investing activities in both periods was capital expenditures. We expect capital expenditures of approximately 2 percent of anticipated revenues in 2014.
FINANCING ACTIVITIES
Cash used for financing activities was $3.2 billion in the first nine months of 2014, compared with $560 in the same period in 2013. Our financing activities include debt issuances and repayments, repurchases of common stock and payment of dividends. Net cash from financing activities also includes proceeds received from stock option exercises, which were relatively consistent period over period.
In the first nine months of 2014, we repurchased approximately 29 million of our outstanding shares. Of this amount, 11.4 million shares were repurchased on January 24, 2014, for $1.2 billion under an accelerated share repurchase (ASR) program facilitated through a financial institution. On February 5, 2014, with shares from the prior authorization largely exhausted by the ASR program, the board of directors authorized management to repurchase 20 million additional shares of common stock on the open market. Subsequently, we repurchased an additional 17.4 million shares for approximately $2 billion. On September 28, 2014, 2.6 million shares remain authorized by our board of directors for repurchase, approximately 1 percent of our total shares outstanding. We repurchased 9.2 million shares for a total of approximately $700 in the first nine months of 2013.
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The final cost of the ASR program will be determined based on the weighted-average daily market price of our stock during the term of the agreement, which expires in the fourth quarter of 2014. If settled in cash, we would anticipate a cash payment of approximately $160 based on appreciation of our stock price through the first nine months of 2014.
On March 5, 2014, our board of directors declared an increased quarterly dividend of $0.62 per share – the 17 th consecutive annual increase. The board had previously increased the quarterly dividend to $0.56 per share in March 2013. The first nine months of 2013 included only two quarterly dividend payments as we accelerated our first quarter 2013 dividend payment to December 2012.
We had no commercial paper outstanding on September 28, 2014. We have $2 billion in bank credit facilities that remain available, including a $1 billion facility expiring in July 2016 and a $1 billion facility expiring in July 2018. These facilities provide backup liquidity to our commercial paper program. We also have an effective shelf registration on file with the Securities and Exchange Commission that allows us to access the capital markets. We plan to renew the shelf registration following its expiration in December 2014. We have no material repayments of long-term debt scheduled until $500 of fixed-rates notes mature in January 2015. As we approach the maturity date of this debt, we will determine whether to repay these notes with cash on hand or refinance the obligation. See Note H to the unaudited Consolidated Financial Statements for additional information regarding our debt obligations, including scheduled debt maturities.
NON-GAAP FINANCIAL MEASURES – FREE CASH FLOW
We define free cash flow from operations as net cash provided by operating activities less capital expenditures. We believe free cash flow from operations is a useful measure for investors, because it portrays our ability to generate cash from our core businesses for purposes such as repaying maturing debt, funding business acquisitions, repurchasing our common stock and paying dividends. We use free cash flow from operations to assess the quality of our earnings and as a performance measure in evaluating management. The following table reconciles the free cash flow from operations with net cash provided by operating activities, as classified on the unaudited Consolidated Statements of Cash Flows:

Nine Months Ended | September 29, 2013 |  | September 28, 2014
Net cash provided by operating activities | $ | 1,553 |  |  | $ | 3,798 |
Capital expenditures | (267 | ) |  | (337 | )
Free cash flow from operations | $ | 1,286 |  |  | $ | 3,461 |
Cash flows as a percentage of earnings from continuing operations: |  |  |
Net cash provided by operating activities | 83 | % |  | 196 | %
Free cash flow from operations | 69 | % |  | 179 | %

We expect to continue to generate funds in excess of our short- and long-term liquidity needs. We believe we have adequate funds on hand and sufficient borrowing capacity to execute our financial and operating strategy, although future cash flows are expected to moderate consistent with our historical experience.
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ADDITIONAL FINANCIAL INFORMATION
ENVIRONMENTAL MATTERS AND OTHER CONTINGENCIES
For a discussion of environmental matters and other contingencies, see Note L to the unaudited Consolidated Financial Statements. We do not expect our aggregate liability with respect to these matters to have a material impact on our results of operations, financial condition or cash flows.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our 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 that we make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the period.
Accounting for long-term contracts and programs involves the use of various techniques to estimate total contract revenues and costs. Contract estimates are based on various assumptions to project the outcome of future events that often span several years. We review our performance monthly and update our contract estimates at least annually and often quarterly, as well as when required by specific events and circumstances. We recognize changes in estimated profit on contracts under the reallocation method. Under this method, the impact of revisions in estimates is recognized prospectively over the remaining contract term. The net increase in our operating earnings (and on a per-share basis) from the favorable impact of revisions in contract estimates totaled $105 ($0.19) and $296 ($0.54) for the three- and nine-month periods ended September 29, 2013, and $13 ($0.02) and $103 ($0.20) for the three- and nine-month periods ended September 28, 2014, respectively. While no revisions on any one contract were material to our unaudited Consolidated Financial Statements in the third quarter and first nine months of 2014, the amount decreased compared with the prior-year periods as 2013 included higher favorable revisions in contract estimates on several programs that neared completion in the Combat Systems and Information Systems and Technology groups.
In the second quarter of 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers. ASU 2014-09 prescribes a single, common standard that replaces most existing revenue recognition guidance in GAAP. The standard outlines a five-step model, whereby revenue is recognized as performance obligations within a contract are satisfied. The standard also requires new, expanded disclosures regarding revenue recognition. ASU 2014-09 is effective in the first quarter of 2017. Early application is not permitted. The standard permits the use of either the retrospective or cumulative effect transition method. We have not yet selected a transition method nor have we determined the effect of the standard on our consolidated financial statements.
The required adoption of the ASU in 2017 will preclude our use of the reallocation method of recognizing revisions in estimated profit on contracts discussed above. Because changes in estimated profit will be recognized in the period they are identified (cumulative catch-up method), rather than prospectively over the remaining contract term, we expect that the impact of revisions of contract estimates may be larger and potentially more variable from period to period. Anticipated losses on contracts will continue to be recognized in the quarter they are identified.
Other significant estimates include those related to goodwill and other intangible assets, income taxes, pensions and other post-retirement benefits, workers’ compensation, warranty obligations and litigation and other contingencies. We employ judgment in making our estimates but they are based on historical experience, currently available information and various other assumptions that we believe to be
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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.
We believe that our judgment is applied consistently and produces financial information that fairly depicts the results of operations for all periods presented. For a full discussion of our critical accounting policies, see our Annual Report on Form 10-K for the year ended December 31, 2013.
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 our Annual Report on Form 10-K for the year ended December 31, 2013.
ITEM 4. CONTROLS AND PROCEDURES
Our management, under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended) on September 28, 2014. Based on this evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, on September 28, 2014, our disclosure controls and procedures were effective.
There were no changes in our internal control over financial reporting that occurred during the quarter ended September 28, 2014, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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,” “outlook,” “estimates,” “should” and variations of these words and similar expressions are intended to identify forward-looking statements. These include but are not limited to projections of revenues, earnings, operating margins, segment performance, cash flows, contract awards, aircraft production, deliveries and backlog. Forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended. These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to predict. Therefore, actual future results and trends may differ materially from what is forecast in forward-looking statements due to a variety of factors, including the risk factors discussed in Item 1A of our Annual Report on Form 10-K. These factors include, without limitation:

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

• | decreases in U.S. government defense spending or changing priorities within the defense budget and the impacts of the Budget Control Act of 2011, including sequester;

• | 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

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• | 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. We do not undertake any obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date of this report except as expressly required to do so by law.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
For information relating to legal proceedings, see Note L 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 our Annual Report on Form 10-K for the year ended December 31, 2013.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table provides information about our third 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* |
Pursuant to Share Buyback Program |  |  |  |
6/30/14-7/27/14 |  | — |  |  | $ | — |  |  | — |  |  | 6,394,152 |
7/28/14-8/24/14 |  | 1,204,000 |  |  | $ | 118.94 |  |  | 1,204,000 |  |  | 5,190,152 |
8/25/14-9/28/14 |  | 2,580,000 |  |  | $ | 126.10 |  |  | 2,580,000 |  |  | 2,610,152 |
Total |  | 3,784,000 |  |  | $ | 123.82 |  |  |  |  |

* On February 5, 2014, the board of directors authorized management to repurchase 20 million shares of common stock.
We did not make any unregistered sales of equity in the third quarter.
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ITEM 6. EXHIBITS

10.1* | Form of Non-Statutory Stock Option Agreement pursuant to the General Dynamics Corporation 2012 Equity Compensation Plan (for certain executive officers who are subject to the General Dynamics Compensation Recoupment Policy)**

10.2* | Form of Restricted Stock Award Agreement pursuant to the General Dynamics Corporation 2012 Equity Compensation Plan (for certain executive officers who are subject to the General Dynamics Compensation Recoupment Policy)**

10.3* | Form of Performance Restricted Stock Unit Award Agreement pursuant to the General Dynamics Corporation 2012 Equity Compensation Plan (for certain executive officers who are subject to the General Dynamics Compensation Recoupment Policy)**

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***

101 | Interactive Data File***

* Indicates a management contract or compensatory plan or arrangement.
** Incorporated herein by reference from the company’s quarterly report on Form 10-Q for the period ended March 30, 2014, filed with the Commission April 23, 2014.
*** Filed herewith.
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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 |
|  | Kimberly A. Kuryea
|  | Vice President and Controller
|  | (Authorized Officer and Chief Accounting Officer)
Dated: October 22, 2014 |  |

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