1
MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE RESULTS OF OPERATIONS AND FINANCIAL
CONDITION
(Dollars in millions, except per share amounts)
FORWARD-LOOKING STATEMENTS
Management's Discussion and Analysis of the Results of Operations and Financial
Condition and other sections of this annual report contain forward-looking
statements that are based on management's expectations, estimates, projections
and assumptions. Words such as "expects," "anticipates," "plans," "believes,"
"estimates," variations of these words and similar expressions are intended to
identify forward-looking statements which include but are not limited to
projections of revenues, earnings, segment performance, cash flows, contract
awards and the company's expectations regarding the upcoming year 2000.
Forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995. These statements are not
guarantees of future performance and involve certain risks and uncertainties,
which are difficult to predict. Therefore, actual future results and trends may
differ materially from what is forecast in forward-looking statements due to a
variety of factors, including, without limitation: the company's successful
execution of internal performance plans; performance issues with key suppliers
and subcontractors; the status or outcome of legal proceedings; the status or
outcome of labor negotiations; changing priorities or reductions in the U.S.
government defense budget; termination of government contracts due to unilateral
government action; and the timing and occurrence (or non-occurrence) of
circumstances beyond the company's control.
BUSINESS OVERVIEW
The company's primary business is supplying sophisticated defense systems to the
United States and its allies. Over the last decade, due to a decline in the U.S.
defense budgets, participants in the defense industry began a process of
contraction and consolidation. The company participated in this shift by
changing its focus to strengthen certain core businesses through both internal
and external means. Management continues to focus on developing advanced
technological solutions to meet its customers' evolving operational requirements
and improving its cost structure. Management believes these initiatives have
created efficient businesses that are positioned to capture new programs and
contracts. The company's businesses have been awarded new programs with the
potential for significant production, as well as several important contracts on
existing programs, that management believes will carry the programs well into
the next century. The anticipated defense programs and plans of the company and
of the U.S. armed forces are subject to, among other events, changing priorities
or reductions in the U.S. government defense budget. However, the company's
programs continue to receive bipartisan support in the defense budget. The
Department of Defense's fiscal year 2000 budget request submitted to Congress in
February 1999 included substantially all of the company's major programs.
Since September 1995, the company has invested approximately $2 billion
in the acquisitions of 11 businesses which have been accretive to earnings.
Management believes these acquisitions have strengthened the company's core
operations, expanded its capabilities to include full systems integration and
data management and extended the company's reach both geographically and in
product mix.
[PHOTO]
MICHAEL J. MANCUSO,
Senior Vice President and
Chief Financial Officer
Management intends to continue to implement its strategy to strengthen
the company through core business revenue growth by positioning it to capture
new programs and contracts; continued improvement in operations; and disciplined
capital deployment, including internal investment and acquisitions.
For its potential acquisitions, the company looks to those that address
all or some of the following strategic criteria:
- - offer the opportunity to achieve savings through consolidation;
- - leverage on the company's operating strength and core competencies;
- - broaden product lines and create synergies among business units;
- - provide technology that improves the company's competitive position.
With $220 in funds on hand after the most recent acquisition and the
capacity for additional long-term borrowing, management believes it has the
financial capability to take advantage of potential opportunities.
[BAR CHART]
NET EARNINGS
1996 $270
1997 $316
1998 $364
OPERATING CASH FLOWS
1996 $415
1997 $528
1998 $352
BUSINESS SEGMENTS
The company operates in three primary business segments: Marine Systems, Combat
Systems and Information Systems and Technology. Marine Systems designs, builds
and supports nuclear submarines and surface combatants for the U.S. Navy and
provides ship management services for the U.S. government on prepositioning and
ready reserve ships. On November 10, 1998, the company acquired control of
NASSCO Holdings
20 GENERAL DYNAMICS 1998 ANNUAL REPORT
2
Incorporated (NASSCO), whose wholly owned subsidiaries include National
Steel and Shipbuilding Company, which is in the business of ship design,
engineering, construction and repair for the U.S. military and various
commercial customers. For a discussion of the accounting for this transaction
and related information, see Note C to the Consolidated Financial Statements.
Net sales of nuclear submarines were $1,381, $1,321 and $1,443 in 1998, 1997 and
1996, respectively. Net sales of surface combatants were $936, $839 and $791 in
1998, 1997 and 1996, respectively.
Combat Systems develops, produces and supports land and amphibious combat
systems, including the U.S. Army's main battle tank, other armored vehicles and
a broad range of power trains, turrets and gun subsystems for the U.S. armed
forces and international customers. It also is a leader in the production of
ammunition products. Net sales of armored vehicles were $915, $960 and $889 in
1998, 1997 and 1996, respectively.
Information Systems and Technology provides expertise in signal and
information processing, the use of commercial technologies for military
applications, battlespace information management and intelligence data
acquisition and processing within the defense and intelligence branches of the
U.S. government and its allies.
The company also owns coal mining and aggregates operations in the
Midwest, and a leasing operation for liquefied natural gas tankers, which are
classified as "Other."
A discussion of each business segment's backlog position (the estimated
remaining sales value of work to be performed under firm contracts), anticipated
programs, operating results and outlook follows. For a summary of business
segment financial information, see Note S to the Consolidated Financial
Statements which is incorporated herein by reference.
MARINE SYSTEMS
[BAR CHART]
BACKLOG
1996 $7,566
1997 $5,864
1998 $11,728
Year-end backlog includes contracts for the construction of the first
four ships of the Virginia-class submarine, formerly known as the New Attack
Submarine, 13 Arleigh Burke class destroyers (DDG 51), five strategic sealift
ships, and the final Seawolf-class attack submarine. A modification to the final
Seawolf is currently under way. The modification is expected to extend the
company's delivery date of the final Seawolf to 2003.
The company's Marine Systems backlog doubled during 1998 due to several
major awards and the acquisition of NASSCO in late 1998.
In September, the Navy awarded a $4.2 billion contract to the company
for the first four ships of the Virginia-class submarine. The Department of
Defense's fiscal year 2000 budget includes funding for a fifth Virginia-class
submarine in fiscal year 2003. The company is scheduled to deliver the lead ship
of the class in 2004. Construction work will be shared equally with the company
as the prime contractor and Newport News Shipbuilding Inc. (Newport News) in the
role of subcontractor, in accordance with the terms of the Team Agreement
entered into in February 1997 between the company and Newport News. Current
Department of Defense plans call for 30 ships in the Virginia-class submarine
program.
In August, the Navy awarded a $68.5 contract to the newly formed DD 21
Shipbuilder Alliance, composed of the company and Ingalls Shipbuilding, a
division of Litton Industries, Inc., for the first phase of system concept
design work for the next generation surface combatant ships (DD 21). The company
will serve as the Alliance prime contractor for the first phases of the DD 21
program and leads one of the Alliance's two competing design teams. Each team
will share equally in the funding of the first phase award, and both
shipbuilders are expected to share equally in the production of the DD 21 ships.
Based on the Navy's plans, the development, design, construction and life-cycle
support of the DD 21 ships is estimated at $25 billion and includes the
construction of 32 ships over 25 years, beginning in 2004.
In March, the Navy awarded a multiyear contract to the company for the
construction of six additional DDG 51s for $2.1 billion. This award extends the
company's deliveries to 2006.
With the acquisition of NASSCO, Marine Systems added approximately $1.2
billion to its backlog. Included in this backlog are contracts for the
construction of five strategic sealift ships for the U.S. Navy. An initial
contract for $1.3 billion for the construction of six ships was awarded to
NASSCO in 1993, with a seventh ship added in 1997 for approximately $200. During
1998, the first two of these ships were delivered to the U.S. Navy. Delivery of
the seventh ship is scheduled for 2001. Also included in this backlog is a
seven-year contract with the U.S. Navy for the phased maintenance of six LHA-
and LHD-class ships for approximately $500, awarded to NASSCO during 1997.
The company is a member of a three-contractor team which in December 1996
was awarded a contract to design and build the Navy's new class of amphibious
transport ships (LPD 17). Congressional funding was previously approved for the
design and construction of the first two LPD 17 ships. The Navy anticipates this
to be a 12-ship program. If the Navy receives Congressional funding for the
remaining 10 ships, the company has agreed with its partners that it will
construct four ships. Congressional funding for the next two ships, one to be
constructed by the company, is contained in the Department of Defense fiscal
year 2000 budget request.
RESULTS OF OPERATIONS AND OUTLOOK
1998 1997 1996
================================================================================
Net Sales $2,666 $2,311 $2,332
Operating Earnings 285 234 216
Operating Margin 10.7% 10.1% 9.3%
- --------------------------------------------------------------------------------
GENERAL DYNAMICS 1998 ANNUAL REPORT 21
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Net sales increased $355 in 1998 due primarily to the acquisition of
NASSCO and the transition of the ballistic missile fire control business to the
Marine Systems segment from the Combat Systems segment. The operating results of
NASSCO have been included with those of the company from the acquisition closing
date, November 10, 1998. Operating earnings increased $51 due to earnings rate
increases on the DDG 51 program in the fourth quarter and on the Seawolf program
in the first quarter. The DDG 51 program continues to realize benefits from cost
reduction efforts and diminishing operating risks as the business base
stabilizes from the 1998 six-ship multiyear award. The Seawolf program continues
to benefit from diminishing operating risks due to the maturity of the program
and stabilization of the business base due to the four-ship Virginia-class
award. The increase in operating earnings resulting from earnings rate increases
was partially offset by a decline in submarine construction activity due to the
delivery of the final Trident during late 1997.
Net sales decreased $21 in 1997 due to lower submarine construction
activity as a result of the delivery of the final Trident and the first Seawolf
submarines. This decrease was partially offset by increased engineering and
design work on the Virginia-class submarine. Operating earnings increased $18
due to earnings rate increases on the DDG 51 program in the fourth quarter and
on the Seawolf program in the third quarter.
Looking forward, Marine Systems operating margins in 1999 are expected to
approximate those reported in 1998. With the delivery of the second Seawolf
submarine in late 1998 and the award of the first four ships of the
Virginia-class submarine, operating risks on submarine programs are expected to
continue to diminish. Additionally, the DDG 51 program is expected to continue
to benefit from cost reduction efforts and stabilization of business base. In
the first quarter of 1999, in order to align the company's information
technology resources, management moved its Defense Systems operating unit from
the Marine Systems segment to the Information Systems and Technology segment.
Net sales for this operating unit were approximately $140 in 1998.
COMBAT SYSTEMS
[BAR CHART]
BACKLOG
1996 $2,057
1997 $2,323
1998 $1,579
The company enters 1999 in its fourth production year of a $1.3 billion
multiyear contract for the upgrade of approximately 600 M1 Abrams tanks to the
M1A2 configuration. Further M1A2 improvements--the System Enhancement
Package--will be incorporated in the last 240 tanks of this multiyear contract,
with deliveries to begin in August 1999. This contract is part of a U.S. Army
procurement program to upgrade approximately 1,150 of the M1 Abrams tanks, with
production anticipated through 2005.
The company is under contract for the development of several other major
systems, including a three-year $300 contract for the design and development of
the Advanced Amphibious Assault Vehicle (AAAV) and construction of at least
three prototypes. Fabrication of the first prototype vehicle began in 1998.
Full-scale production is expected to begin in 2005. The Marine Corps plans to
procure more than 1,000 vehicles in the next decade, a production program worth
as much as $4 billion.
The Crusader Self-Propelled Howitzer program remains the Army's largest
single research and development program; the company's share is approximately 25
percent. The U.S. Army plans to build more than 800 Crusader systems, a
production program that could be worth as much as $13 billion.
Other mature production programs in Combat Systems backlog include
several major components of the Bradley combat vehicle and its derivatives;
Hydra 70 Rocket; diesel engines; and a four-year program to upgrade Fox Nuclear,
Biological and Chemical Reconnaissance System vehicles. In May 1998, the company
received a $106 contract from the U.S. Army to begin initial production of the
Wolverine Heavy Assault Bridge, a derivative of the Abrams M1 platform. The
first vehicle is scheduled for delivery in August 1999, with full-rate
production expected to begin in 2000.
In October 1998, the company's Armament Systems operating unit formed a
joint venture with Mason & Hanger Corporation that consolidated two of the U.S.
Army's ammunition production facilities. Previously a consolidated subsidiary,
the company's Milan Army Ammunition Plant is now part of the unconsolidated
joint venture, American Ordnance LLC. This joint venture is expected to lower
costs and improve overall profit margins on the ordnance production programs.
The company's share of American Ordnance's pretax earnings are included with
those of the Combat Systems segment's operating earnings from its date of
formation. Annualized revenues for the company's previous Milan operations were
approximately $75. The joint venture's backlog was approximately $150 at the end
of 1998.
RESULTS OF OPERATIONS AND OUTLOOK
1998 1997 1996
================================================================================
Net Sales $1,272 $1,509 $1,026
Operating Earnings 166 187 140
Operating Margin 13.1% 12.4% 13.6%
- --------------------------------------------------------------------------------
Net sales decreased $237 in 1998 due primarily to the aforementioned
transfer of the ballistic missile fire control business to the Marine Systems
segment and completion of production on the Single Channel Ground and Airborne
Radio System (SINCGARS). Net sales for the ballistic missile fire control
business were approximately $120 in 1997. Operating earnings decreased $21 in
1998 due to the aforementioned declines in sales, including the timing of land
combat program
22 GENERAL DYNAMICS 1998 ANNUAL REPORT
4
deliveries, partially offset by higher margins obtained from the SINCGARS
program as production was completed.
Net sales increased $483 and operating earnings increased $47 during 1997
due primarily to the acquisition of Defense Systems and Armament Systems from
Lockheed Martin Corporation on January 1, 1997. For a discussion of the
accounting for this transaction and related information, see Note C to the
Consolidated Financial Statements. Excluding the results of the acquisitions,
net sales decreased five percent due primarily to decreased tank kit production
resulting from delivery of the last 48 kits to Egypt as part of the
co-production program in early 1997. This decrease was partially offset by
increased activity on the AAAV program.
Looking forward, the company continues to seek improvements in operating
margins in the Combat Systems segment through efforts to reduce costs and
pursuit of international sales, including foreign military sales of tanks to
Egypt, Greece, Turkey and Saudi Arabia. While operating margins are subject to
quarter-to-quarter variations, the company expects full-year 1999 operating
margins to approximate those reported in 1998.
INFORMATION SYSTEMS AND TECHNOLOGY
This recently formed segment is the result of a series of acquisitions of
technology companies which are intended to provide the company with broader and
deeper capabilities in electronics, systems integration and information
management; extend the company's presence geographically; and enable the company
to share technology across business segments.
In 1998, the company completed two additional acquisitions. On August 3,
the company acquired the assets of Caldwell Cable Ventures Inc., a provider of
underwater fiberoptic and power cable installation. Caldwell Cable Ventures
operates as a subsidiary of Advanced Technology Systems. On June 30, the company
acquired the assets of Computer Systems & Communications Corporation, a systems
integration and communications company serving the U.S. Department of Defense
and other NATO countries. For a discussion of the accounting for these
transactions and related information, see Note C to the Consolidated Financial
Statements. The operating results of these acquired businesses are included with
those of the company from their respective closing dates.
The segment's net sales were $796 and operating earnings were $59 for the
year ended December 31, 1998. Year-end backlog for this segment totaled
approximately $700 and includes contracts at Advanced Technology Systems for
continued sales of commercial undersea fiber optic products and sales involving
light-wave based transmission systems to various government customers. Contracts
at Computing Devices Canada include completion of the IRIS integrated
communications system, sonar integration on the Swedish Hydra program, upgrading
of AWACS display consoles and development of a landmine detection system. At
General Dynamics Information Systems, backlog includes a contract to improve an
advanced radar signal processor used in the Joint STARS airborne surveillance
program. Backlog at Computing Devices Company in the United Kingdom includes a
contract for production work on the Eurofighter program, a partnership program
worth approximately $600 over the 20-year contract period.
The company continues to seek improvements in operating margins in
Information Systems and Technology through efforts to reduce costs. During the
second half of this year, the company initiated internal actions to consolidate
the electronics manufacturing processes of the segment in Advanced Technology
Systems' Greensboro, North Carolina, facility. In the first quarter of 1999, as
previously mentioned, management transitioned Defense Systems' business to the
Information Systems and Technology segment.
OTHER
1998 1997 1996
================================================================================
Net Sales $236 $242 $223
Operating Earnings 32 25 (3)
- --------------------------------------------------------------------------------
In 1997, Freeman United Coal Mining Company (Freeman) elected to withdraw
from the Bituminous Coal Operators' Association (BCOA) and negotiate future
contracts independently with the United Mine Workers of America union (UMWA).
Freeman's labor contract as part of the BCOA expired on August 1, 1998. On
September 11, 1998, the union workforce, representing approximately seventy
percent of Freeman's total workforce, went on strike. On December 21, 1998, the
strike ended and the company reached a new collective bargaining agreement with
its UMWA represented employees. The company believes the terms of the contract,
which extend to February 2003, will provide it with cost savings.
Despite the impact of the strike at Freeman, operating earnings increased
$7 during 1998 due primarily to improved performance of the aggregates business
as a result of improved shipments due to favorable weather conditions and
reduction in cost, as well as cost reduction efforts at the coal mining
operations.
Operating earnings increased $28 during 1997 due primarily to the
suspension of coal mining activity at an unprofitable location in early 1997.
ADDITIONAL FINANCIAL INFORMATION
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses
increased during 1998 due primarily to business acquisitions. As a percentage of
net sales, however, general and administrative expenses have remained consistent
with 1997 and 1996 amounts.
INTEREST INCOME, NET. Interest income was $16 in 1998, down from $40 in
1997 and $59 in 1996 due primarily to a decline in the average cash balance
resulting from the use of $1.5 billion for business acquisitions during 1998 and
1997. Interest expense for 1998 increased over 1997 and 1996 as a result of
borrowings made in connection with the Computing Devices International
acquisition at the end of 1997.
OTHER INCOME, NET. Other income varies from period to period based on the
timing of transactions such as the sales of investments and miscellaneous
assets.
PROVISION FOR INCOME TAXES. On March 2, 1999, the company was notified
that the Joint Committee on Taxation approved the settlement of the company's
tax refund claims
GENERAL DYNAMICS 1998 ANNUAL REPORT 23
5
for research and experimentation tax credits for 1987 through 1989. The company
expects to net approximately $250 after-tax cash during the second quarter of
1999, including settlement amounts carried forward from tax years 1981 through
1986. The company is presently evaluating the income effect of these
settlements, and expects to recognize substantial income from the event in the
first quarter of 1999. For further discussion of this and other tax matters, as
well as a discussion of the net deferred tax asset, see Notes B and E to the
Consolidated Financial Statements.
EARNINGS PER SHARE. On March 4, 1998, the company's board of directors
authorized a two-for-one stock split effected in the form of a 100 percent stock
dividend. Accordingly, earnings per share data has been restated to give
retroactive recognition to the stock split in prior periods.
YEAR 2000. The company has developed an internal Year 2000 compliance
program (Y2K Project), which is focusing on three major areas of assessment,
project planning and remediation with respect to Year 2000 issues (the inability
of date-sensitive software and equipment to properly recognize dates beyond
1999): (1) information technology systems; (2) deliverable software (alone or as
a component of another product); and (3) facilities and embedded processors. The
company is working with its full-time information technology systems partner on
the project. The assessment and project planning phase of the Y2K Project is
substantially complete. The company expects the remediation phase to be
substantially complete by the end of the first quarter of 1999. Validation
testing occurs as systems are remediated and is expected to be finished in the
third quarter of 1999. The company generally develops its deliverable software
to conform with customer specifications. The company is completing its review of
customer contracts and specifications to determine whether any Year 2000 issues
exist. Remediation efforts have been undertaken where requested, required and/or
funded by the customer. Management believes the company will complete the Y2K
Project on schedule and that the costs to implement will not materially impact
results of operations or financial condition, as most of these costs are
expected to be allowable under the company's U.S. government contracts. The
company believes its total Y2K Project costs will not exceed $40.
The company has made inquiries of substantially all third parties with
whom it has material business relationships to determine if they have Year 2000
issues. To date, the company has not been made aware of any Year 2000 issues
with respect to these third parties that would be expected to materially and
adversely affect the company. There can be no assurance, however, that these
third parties have been or will be successful in identifying or addressing their
Year 2000 issues.
The implementation schedule, projected costs and beliefs regarding the
company's Year 2000 issues detailed above are based on management's best
estimates utilizing various assumptions as to future events. There can be no
assurances that these expectations will be realized. Based on the status of the
Y2K Project and third-party surveys, however, the company does not believe there
are any material risks to the company related to Year 2000 issues. The company
believes its worst case Year 2000 scenario, if realized, would involve a brief
slowdown or cessation of production at one or more business units which would
not be expected to have a material adverse effect on financial condition or
results of operations. The company engages in continual monitoring, project
reviews and internal audit activities designed to ensure Year 2000 readiness.
The company has begun, and expects to complete during the second quarter of
1999, contingency planning with respect to Year 2000 issues.
MARKET RISK. The company's investment securities carry fixed rates of
interest over their respective maturity terms. The company does not use
derivative instruments to alter the interest characteristics of these
instruments. The aggregate fair value of the company's financial instruments
approximates the carrying value at December 31, 1998.
In connection with the long-term financing arrangement completed in
September 1998, the company entered into an agreement to reduce the exposure to
interest rate and foreign currency rate fluctuations. The company does not
expect these transactions to have a material effect on the company's results of
operations or financial condition.
The company's foreign operations attempt to minimize the effects of
currency risk by borrowing externally in the local currency and by hedging their
limited purchases made in foreign currencies when practical. As a matter of
policy, the company does not engage in currency speculation.
With the acquisition of Computing Devices International, the company is
exposed to the effect of foreign currency fluctuations on the U.S. dollar value
of earnings of Computing Devices Canada and Computing Devices Company in the
U.K. The company does not expect the impact of foreign currency fluctuations to
be material to the company's results of operations or financial condition.
NEW ACCOUNTING STANDARDS. In June 1998, the Financial Accounting
Standards Board issued Statement of Financial Accounting Standards (SFAS) No.
133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in other contracts, and for
hedging activities. The company is required to adopt the provisions of the
standard during the first quarter of 2000. Because of the company's minimal use
of derivatives, the company does not expect that the adoption of the new
standard will have a material impact on the results of operations or financial
condition.
Effective January 1, 1998, the company adopted the provisions of
Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use." SOP 98-1 provides authoritative
guidance on accounting for the costs of computer software developed or obtained
for internal use and provides authoritative guidance for determining whether
computer software is for internal use. The adoption of the SOP did not have a
material impact on the company's results of operations or financial condition.
The Accounting Standards Executive Committee issued SOP 97-3, "Accounting
by Insurance and Other Enterprises for Insurance-Related Assessments," in
December 1997. SOP 97-3 provides guidance to aid in the determination of when
liabilities should be recognized for guaranty-fund and other insurance-related
assessments, as well as requirements for the measurement of the liability and
related recoverable asset. The company is required to adopt the provisions of
SOP 97-3 in 1999 and expects that it will not have a material impact on the
results of operations or financial condition.
24 GENERAL DYNAMICS 1998 ANNUAL REPORT
6
FINANCIAL CONDITION
The company's liquidity and financial condition remained strong during 1998,
enabling the company to acquire three additional businesses during the year for
approximately $300. The company ended the year with $220 of cash and equivalents
and marketable securities, a strong balance sheet and the capacity for
additional long-term borrowings. A discussion of the company's financial
condition in terms of its operating, investing and financing activities as
defined in the Consolidated Statement of Cash Flows follows.
OPERATING ACTIVITIES--CONTINUING. The net cash provided by continuing
operations is summarized by type as follows:
Year Ended December 31
1998 1997 1996
================================================================================
Operations $424 $ 581 $ 520
Allocated federal income
tax payments (110) (115) (127)
Other 38 62 22
- --------------------------------------------------------------------------------
Operating cash flows 352 528 415
Decrease in marketable
securities, net 30 62 742
- --------------------------------------------------------------------------------
Net cash provided by
continuing operations $382 $ 590 $1,157
- --------------------------------------------------------------------------------
The four types of cash flows are described as follows:
- - Operations represent the pretax cash flows generated by the company's
business segments. Due to the deliveries of two maturing submarine
programs during 1997, cash flows from operations exceeded operating
earnings plus depreciation and amortization for each of the years ended
December 31, 1997 and 1996. This trend is not expected to continue due to
the production growth on several new programs, including the
Virginia-class submarine and light armored vehicles. Even though the
company anticipates investing in working capital during this production
growth life cycle, the company still expects to generate funds from
operations in excess of its short- and long-term liquidity needs.
- - For purposes of preparing the Consolidated Statement of Cash Flows,
federal income tax payments are allocated between continuing and
discontinued operations based on the portion of taxable income attributed
to each.
- - Other cash flows include items that are not directly attributable to a
business segment, such as interest received from investments in excess of
interest paid on debt.
- - In accordance with SFAS No. 115, "Accounting for Certain Investments in
Debt and Equity Securities," the purchases, sales and maturities of
marketable securities classified as trading are reflected as cash flows
from operating activities. The decrease in each of the three years in the
period ended December 31, 1998, was due to the company altering its
investment portfolio to include more available-for-sale securities, which
are included in investing activities.
OPERATING ACTIVITIES--DISCONTINUED. Cash flows from discontinued
operations improved during 1998 due primarily to decreased payments for
disposition-related liabilities. For discussion of the A-12 program litigation,
see Note P to the Consolidated Financial Statements.
INVESTING ACTIVITIES. On February 10, 1999, the company made an offer to
the board of directors of Newport News to acquire the outstanding shares of
Newport News for $38.50 per share. The proposed transaction is subject to
various conditions, including regulatory approvals and acceptance by the board
of directors and shareholders of Newport News. If the transaction goes forward,
the company would fund the expected acquisition cost of approximately $1.5
billion with existing and new credit facilities.
As previously discussed, the company acquired three businesses in 1998
and six businesses in 1997. For further discussion of each acquisition, see Note
C to the Consolidated Financial Statements. The company liquidated substantially
all of its available-for-sale investment portfolio in order to acquire these
businesses. The remaining fixed purchase consideration of $51 in cash for three
individual stockholders' share of NASSCO common stock will be paid from
available funds on May 5, 1999.
The company commenced a project to modernize the facilities and to
improve productivity at its Bath Iron Works' shipyard in late 1997. The company
anticipates investing approximately $200 over a period of three years.
Construction began in November 1998.
Following the sale in 1993 and 1994 of the company's operations located
in southern California, the company retained certain properties. These
properties have been segregated on the Consolidated Balance Sheet as real estate
held for development. Development work began in 1994 on certain of the
properties in order to maximize the value the company receives from their sale.
In 1998, the company completed the sale of a 232-acre site in the Kearny Mesa
section of San Diego for approximately $80 in cash, and in 1997, received $23 in
cash from the sale of certain other assets related to these properties.
FINANCING ACTIVITIES. In connection with the company's acquisition of
Computing Devices International on December 31, 1997, the company borrowed in
Canadian dollars the U.S. equivalent of $220. The company repaid $70 of this
note during 1998 and refinanced the balance in September 1998 under a 10-year
arrangement.
The company exercised its option to call for the early redemption of all
of its outstanding 9.95 percent Debentures on April 1, 1998, for a total of
approximately $40.
On March 3, 1999, the company's board of directors declared an increased
regular quarterly dividend of $.24 per share. The company had previously
increased the quarterly dividend to $.22 per share in March 1998 and to $.205
per share in March 1996.
In 1994, the board of directors reconfirmed management's authority to
repurchase, at its discretion, up to six million shares of the company's common
stock. During 1998, 1997 and 1996, the company repurchased approximately
600,000, 1.8 million and 780,000 shares, respectively, of its stock on the open
market for a total of $28, $60 and $23, respectively. As of December 31, 1998,
the company had repurchased approximately 4.3 million shares.
The company has the capacity for long-term borrowings and currently has
available a committed, $400 line of credit expiring in December 2002.
GENERAL DYNAMICS 1998 ANNUAL REPORT 25
7
CONSOLIDATED STATEMENT OF EARNINGS
Year Ended December 31
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) 1998 1997 1996
==================================================================================================================================
NET SALES $4,970 $4,062 $3,581
OPERATING COSTS AND EXPENSES 4,428 3,616 3,228
- -----------------------------------------------------------------------------------------------------------------------------
OPERATING EARNINGS 542 446 353
Interest income, net 4 36 55
Other income (expense), net 3 (3) 1
- -----------------------------------------------------------------------------------------------------------------------------
EARNINGS BEFORE INCOME TAXES 549 479 409
Provision for income taxes 185 163 139
- -----------------------------------------------------------------------------------------------------------------------------
NET EARNINGS $ 364 $ 316 $ 270
- -----------------------------------------------------------------------------------------------------------------------------
NET EARNINGS PER SHARE:
Basic $ 2.88 $ 2.51 $ 2.14
Diluted $ 2.86 $ 2.50 $ 2.13
- -----------------------------------------------------------------------------------------------------------------------------
The accompanying Notes to Consolidated Financial Statements are an integral part
of this statement.
26 GENERAL DYNAMICS 1998 ANNUAL REPORT
8
CONSOLIDATED BALANCE SHEET
December 31
(DOLLARS IN MILLIONS) 1998 1997
============================================================================================================================
ASSETS
- -----------------------------------------------------------------------------------------------------------------------
CURRENT ASSETS:
Cash and equivalents $ 127 $ 336
Marketable securities 93 105
- -----------------------------------------------------------------------------------------------------------------------
220 441
- -----------------------------------------------------------------------------------------------------------------------
Accounts receivable 316 234
Contracts in process 952 702
Other current assets 385 312
- -----------------------------------------------------------------------------------------------------------------------
Total Current Assets 1,873 1,689
- -----------------------------------------------------------------------------------------------------------------------
NONCURRENT ASSETS:
Leases receivable--finance operations 181 193
Real estate held for development 65 128
Property, plant and equipment, net 698 592
Intangible assets 1,525 1,204
Other assets 230 285
- -----------------------------------------------------------------------------------------------------------------------
Total Noncurrent Assets 2,699 2,402
- -----------------------------------------------------------------------------------------------------------------------
$4,572 $4,091
- -----------------------------------------------------------------------------------------------------------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
- -----------------------------------------------------------------------------------------------------------------------
CURRENT LIABILITIES:
Current portion of long-term debt $ 2 $ 108
Short-term debt--finance operations 58 18
Accounts payable 295 255
Other current liabilities 1,106 910
- -----------------------------------------------------------------------------------------------------------------------
Total Current Liabilities 1,461 1,291
- -----------------------------------------------------------------------------------------------------------------------
NONCURRENT LIABILITIES:
Long-term debt 167 157
Long-term debt--finance operations 82 100
Other liabilities 643 628
Commitments and contingencies (See Note O)
- -----------------------------------------------------------------------------------------------------------------------
Total Noncurrent Liabilities 892 885
- -----------------------------------------------------------------------------------------------------------------------
SHAREHOLDERS' EQUITY:
Common stock, including surplus (shares issued 168,774,672) 285 220
Retained earnings 2,640 2,386
Treasury stock (shares held 1998, 42,081,130 ; 1997, 42,989,118) (706) (691)
Accumulated other comprehensive income -- --
- -----------------------------------------------------------------------------------------------------------------------
Total Shareholders' Equity 2,219 1,915
- -----------------------------------------------------------------------------------------------------------------------
$4,572 $4,091
- -----------------------------------------------------------------------------------------------------------------------
The accompanying Notes to Consolidated Financial Statements are an integral part
of this statement.
GENERAL DYNAMICS 1998 ANNUAL REPORT 27
9
CONSOLIDATED STATEMENT OF CASH FLOWS
Year Ended December 31
(DOLLARS IN MILLIONS) 1998 1997 1996
======================================================================================================================
CASH FLOWS FROM OPERATING ACTIVITIES:
Net earnings $ 364 $ 316 $ 270
Adjustments to reconcile net earnings to net cash provided by
continuing operations--
Depreciation, depletion and amortization 126 91 67
Decrease (Increase) in assets, net of effects of business acquisitions--
Marketable securities 30 62 742
Accounts receivable (17) (6) 25
Contracts in process (209) 86 41
Leases receivable--finance operations 11 10 8
Other current assets 5 18 --
Increase (Decrease) in liabilities, net of effects of business acquisitions--
Accounts payable and other current liabilities 8 (35) 2
Current income taxes 99 66 76
Deferred income taxes (2) (15) (61)
Other, net (33) (3) (13)
- --------------------------------------------------------------------------------------------------------------------
Net cash provided by continuing operations 382 590 1,157
Net cash used by discontinued operations (12) (33) (121)
- --------------------------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities 370 557 1,036
- --------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Business acquisitions, net of cash acquired (256) (1,230) (59)
Purchases of available-for-sale securities (443) (440) (986)
Sales/maturities of available-for-sale securities 493 916 484
Capital expenditures (158) (83) (75)
Proceeds from sale of assets 24 11 41
Proceeds from sale of real estate held for development 74 23 --
Other (3) (5) (10)
- --------------------------------------------------------------------------------------------------------------------
Net Cash Used by Investing Activities (269) (808) (605)
- --------------------------------------------------------------------------------------------------------------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of debt -- 220 --
Proceeds from issuance of debt--finance operations -- -- 150
Repayment of debt (157) -- --
Repayment of debt--finance operations (38) (17) (158)
Dividends paid (108) (102) (101)
Purchase of common stock (28) (60) (23)
Proceeds from option exercises 23 30 8
Other (2) -- (6)
- --------------------------------------------------------------------------------------------------------------------
Net Cash (Used) Provided by Financing Activities (310) 71 (130)
- --------------------------------------------------------------------------------------------------------------------
NET (DECREASE) INCREASE IN CASH AND EQUIVALENTS (209) (180) 301
CASH AND EQUIVALENTS AT BEGINNING OF YEAR 336 516 215
- --------------------------------------------------------------------------------------------------------------------
CASH AND EQUIVALENTS AT END OF YEAR $ 127 $ 336 $ 516
- --------------------------------------------------------------------------------------------------------------------
The accompanying Notes to Consolidated Financial Statements are an integral part
of this statement.
28 GENERAL DYNAMICS 1998 ANNUAL REPORT
10
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
Accumulated
Common Stock Treasury Stock Other
-------------------------- Retained ----------------- Comprehensive
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AMOUNTS) Shares Par Surplus Earnings Shares Amount Income
===================================================================================================================================
BALANCE, DECEMBER 31, 1995 168,774,672 $169 $11 $2,005 42,283,922 $625 $7
- -----------------------------------------------------------------------------------------------------------------------------------
Net earnings 270
Unrealized gains on securities,
net of reclassification adjustment (6)
Cash dividends declared
($.82 per share) (103)
Shares purchased 783,800 23
Shares issued under Incentive
Compensation Plan 11 (497,408) 2
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1996 168,774,672 169 22 2,172 42,570,314 650 1
- -----------------------------------------------------------------------------------------------------------------------------------
Net earnings 316
Unrealized gains on securities,
net of reclassification adjustment (1)
Cash dividends declared
($.82 per share) (102)
Shares purchased 1,832,500 60
Shares issued under Incentive
Compensation Plan 29 (1,413,696) (19)
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1997 168,774,672 169 51 2,386 42,989,118 691 --
- -----------------------------------------------------------------------------------------------------------------------------------
Net earnings 364
Unrealized gains on securities 1
Foreign currency translation
adjustment (1)
Cash dividends declared
($.88 per share) (110)
Shares purchased 598,000 28
Shares issued for business acquisition 4 (157,283) (3)
Shares issued under Incentive
Compensation Plan 61 (1,348,705) (10)
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE, DECEMBER 31, 1998 168,774,672 $169 $116 $2,640 42,081,130 $706 $--
- -----------------------------------------------------------------------------------------------------------------------------------
The accompanying Notes to Consolidated Financial Statements are an integral
part of this statement.
GENERAL DYNAMICS 1998 ANNUAL REPORT 29
11
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in millions, except per share amounts)
A. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION. The Consolidated Financial Statements include
the accounts of the company and all majority-owned subsidiaries.
ACCOUNTING ESTIMATES. The preparation of financial statements in conformity
with generally accepted accounting principles (GAAP) requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from these estimates.
SALES AND EARNINGS UNDER LONG-TERM CONTRACTS AND PROGRAMS. Defense programs
are accounted for using the percentage-of-completion method of accounting. The
combination of estimated profit rates on similar, economically interdependent
contracts is used to develop program earnings rates for contracts that meet
Statement of Position (SOP) 81-1 criteria. These rates are applied to contract
costs, including general and administrative expenses, for the determination of
sales and operating earnings. Program earnings rates are reviewed quarterly to
assess revisions in contract values and estimated costs at completion. Based on
these assessments, any changes in earnings rates are made prospectively.
Any anticipated losses on contracts or programs are charged to earnings when
identified. Such losses encompass all costs, including general and
administrative expenses, allocable to the contracts. Revenue arising from the
claims process is not recognized either as income or as an offset against a
potential loss until it can be reliably estimated and its realization is
probable.
GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative expenses were
$384, $334 and $275 in 1998, 1997 and 1996, respectively, and are included in
operating costs and expenses on the Consolidated Statement of Earnings.
INTEREST, NET. Interest income was $16, $40 and $59 in 1998, 1997 and 1996,
respectively. Interest payments, including the company's finance operations,
were $18, $12 and $14 in 1998, 1997 and 1996, respectively. Interest expense
incurred by the company's finance operations is classified as operating costs
and expenses.
CASH AND EQUIVALENTS AND MARKETABLE SECURITIES. The company classifies its
securities based on the remaining maturity at the time of purchase. The company
considers securities with a maturity of three months or less to be cash
equivalents. The company adjusts all marketable securities to fair value. In
general, market adjustments to those securities with maturities less than one
year are recognized in earnings and included as a component of accumulated
other comprehensive income for securities with maturities greater than one
year. At December 31, 1998, marketable securities consist primarily of
corporate debt and government backed mortgage securities.
ACCOUNTS RECEIVABLE AND CONTRACTS IN PROCESS. Accounts receivable represent
only amounts billed and currently due from customers. Recoverable costs and
accrued profit related to long-term contracts and programs on which revenue has
been recognized, but billings have not been presented to the customer (unbilled
receivables), are included in contracts in process.
PROPERTY, PLANT AND EQUIPMENT. Property, plant and equipment is carried at
historical cost net of accumulated depreciation. The company primarily uses
accelerated methods of depreciation for depreciable assets. Depletion of
mineral reserves is computed using the units-of-production method. Depreciation
expense was $83, $70 and $59 in 1998, 1997 and 1996, respectively.
IMPAIRMENT OF LONG-LIVED ASSETS. Long-lived assets, identifiable intangibles
and goodwill are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. In performing the review for recoverability, the company estimates
the future cash flows expected to result from the use of the asset. If the
asset is held for sale, the company reviews its fair value less cost to sell.
ENVIRONMENTAL LIABILITIES. The company accrues environmental costs when it is
probable that a liability has been incurred and the amount can be reasonably
estimated. Cleanup and other environmental exit costs related to sold
businesses were recorded at the time of disposal. Recorded liabilities have not
been discounted. To the extent the U.S. government has specifically agreed to
pay the ongoing maintenance and monitoring costs at sites currently used in the
conduct of the company's government contracting business, these costs are
treated as contract costs and recognized as paid.
STOCK-BASED COMPENSATION. The company measures compensation cost for stock
options as the excess, if any, of the quoted market price of the company's
stock at the measurement date over the exercise price. Stock awards are
recorded at fair value at the date of award.
TRANSLATION OF FOREIGN CURRENCIES. Local currencies have been determined to
be functional currencies for the company's international operations. Foreign
currency balance sheets are translated at the end-of-period exchange rates and
earnings statements at the average exchange rates for each period. The
resulting foreign currency translation adjustments are included in the
calculation of accumulated other comprehensive income and included in the
equity section on the Consolidated Balance Sheet.
COMPREHENSIVE INCOME. Effective January 1, 1998, the company adopted the
provisions of Statement of Financial Accounting Standards (SFAS) No. 130,
"Reporting Comprehensive Income," which requires the presentation and
30 GENERAL DYNAMICS 1998 ANNUAL REPORT
12
disclosure of comprehensive income. Comprehensive income was $364, $315 and
$264 in 1998, 1997 and 1996, respectively.
CLASSIFICATION. Consistent with industry practice, assets and liabilities
relating to long-term contracts and programs are classified as current although
a portion of these amounts is not expected to be realized within one year. In
addition, certain prior year amounts have been reclassified to conform to the
current year presentation.
B. SUBSEQUENT EVENTS
On March 2, 1999, the company was notified that the Joint Committee on Taxation
approved the settlement of the company's tax refund claims for research and
experimentation tax credits for 1987 through 1989. The company expects to net
approximately $250 after-tax cash during the second quarter of 1999, including
settlement amounts carried forward from tax years 1981 through 1986. The
company is presently evaluating the income effect of these settlements, and
expects to recognize substantial income from the event in the first quarter of
1999.
On February 10, 1999, the company made an offer to the board of directors of
Newport News Shipbuilding Inc. (Newport News) to acquire the outstanding shares
of Newport News for $38.50 per share. The proposed transaction is subject to
various conditions, including regulatory approvals and acceptance by the board
of directors and shareholders of Newport News.
C. ACQUISITIONS
On November 10, 1998, the company acquired control of NASSCO Holdings
Incorporated (NASSCO). The purchase consideration for 100 percent of NASSCO
will be $369 in cash plus the obligation to discharge $46 in debt. The company
paid $318 of the total consideration and repaid the $46 obligation in cash
during November 1998 for the portion of NASSCO held by the NASSCO Holdings
Incorporated Employee Stock Ownership Plan. The remaining fixed purchase
consideration of $51 will be paid to three individual stockholders in cash on
May 5, 1999, in consideration for their share of NASSCO common stock.
NASSCO's wholly owned subsidiaries include National Steel and Shipbuilding
Company, which is in the business of ship design, engineering, construction and
repair for the United States military and various commercial customers, and
NASSCO Funding Corporation, a finance subsidiary. See Note M for further
details related to this finance operation. The company made two other
acquisitions during 1998 for approximately $20 in cash and stock.
Effective December 31, 1997, the company purchased the assets of Computing
Devices International, formerly a division of Ceridian Corporation, for
approximately $500, net of cash acquired of $100. The company borrowed $220 in
connection with the acquisition. See Note J for details on the terms of the
debt. Computing Devices International added three new defense electronics and
system integration units to the company, General Dynamics Information Systems,
Computing Devices Canada Ltd. and Computing Devices Company Limited in the
United Kingdom.
Effective October 1, 1997, the company purchased the assets of Advanced
Technology Systems, formerly an operating unit of Lucent Technologies, for
$267, net of purchase price adjustment of $17 received in January 1998.
Advanced Technology Systems is a leading supplier of undersea surveillance
systems, signal processing and vibration control systems and related
technologies for a wide range of applications.
Effective January 1, 1997, the company purchased the assets of Defense
Systems and Armament Systems, formerly operating units of Lockheed Martin
Corporation, for $450 in cash. Defense Systems builds missile guidance and
naval fire control systems. Their manufacture of light vehicles and turrets and
transmissions for combat vehicles was transferred to another operating unit of
the company in early 1998. Armament Systems designs, develops and produces
advanced gun, ammunition handling and air defense systems, and is a leader in
the production of ammunition and ordnance products.
Each of these acquisitions has been accounted for under the purchase method
of accounting. The purchase prices have been allocated to the estimated fair
values of net tangible assets acquired, with any excess recorded as intangible
assets (see Note H). Certain of the estimates related to the acquisition of
NASSCO are still preliminary at December 31, 1998, but will be finalized within
one year from its date of acquisition. The operating results of the acquired
businesses are included with those of the company from their respective closing
dates.
D. EARNINGS PER SHARE
The company has adopted the provisions of SFAS No. 128, "Earnings Per Share,"
which requires the presentation of earnings per share on both a basic and
diluted basis for all periods presented. Basic and diluted weighted average
shares outstanding are as follows (in thousands):
Year Ended December 31
1998 1997 1996
- -------------------------------------------------------------------------
Basic weighted average
shares outstanding 126,377 125,674 126,343
Assumed exercise
of options 811 712 517
Contingently issuable
shares 22 194 60
- -------------------------------------------------------------------------
Diluted weighted average
shares outstanding 127,210 126,580 126,920
- -------------------------------------------------------------------------
GENERAL DYNAMICS 1998 ANNUAL REPORT 31
13
E. INCOME TAXES
The provision for U.S. federal and foreign income taxes included on the
Consolidated Statement of Earnings is summarized as follows:
Year Ended December 31
1998 1997 1996
=================================================
Current:
U.S. Federal $172 $178 $200
Foreign 15 -- --
- -------------------------------------------------
Total current 187 178 200
- -------------------------------------------------
Deferred:
U.S. Federal 7 (15) (61)
Foreign (9) -- --
- -------------------------------------------------
Total deferred (2) (15) (61)
- -------------------------------------------------
$185 $163 $139
=================================================
The provision for state and local income taxes, which is allocable to U.S.
government contracts, is included in operating costs and expenses.
The reconciliation from the statutory federal income tax rate to the
company's effective income tax rate is as follows:
Year Ended December 31
1998 1997 1996
====================================================
Statutory income tax rate 35% 35% 35%
Other (1) (1) (1)
- ----------------------------------------------------
Effective income tax rate 34% 34% 34%
====================================================
The tax effects of temporary differences that give rise to significant
portions of deferred tax assets and liabilities consist of the following:
December 31
1998 1997
=================================================
Long-term contract costing
methods $ 90 $ 98
A-12 termination 93 95
Accrued costs on disposed
businesses 62 74
Coal mining liabilities 26 27
Postretirement liabilities 47 43
Tax loss carryforwards 33 --
Other 208 121
- -------------------------------------------------
Deferred Assets $559 $458
- -------------------------------------------------
Lease income $ 66 $ 70
Commercial pension asset 52 48
Intangible assets 46 38
Property basis differences 25 6
Other 83 11
- -------------------------------------------------
Deferred Liabilities $272 $173
- -------------------------------------------------
Net Deferred Asset $287 $285
=================================================
No material valuation allowance was required for the company's deferred tax
assets at December 31, 1998 and 1997. The current portion of the net deferred
tax asset is $311 and $223 at December 31, 1998 and 1997, respectively, and is
included in other current assets on the Consolidated Balance Sheet.
The company made U.S. federal and foreign income tax payments of $108,
$97 and $199 in 1998, 1997 and 1996, respectively.
The company and the U.S. Internal Revenue Service (IRS) settled refund claims
for research and experimentation tax credits for the years 1981 through 1989 for
approximately $250 (including after-tax interest). See Note B for further
discussion.
The IRS has completed its examination of the company's 1990 through 1993
consolidated federal income tax returns. Unresolved matters for these years will
be protested to the IRS Appeals Division. A refund claim by the company for $78
(plus interest) for research and experimentation tax credits for the year 1990
will also be considered by the IRS Appeals Division. The IRS is currently
examining the company's 1994 and 1995 consolidated federal income tax returns.
Since the company has recorded liabilities for tax contingencies, resolution of
these years is not expected to have a materially unfavorable impact on the
company's results of operations or financial condition.
F. CONTRACTS IN PROCESS
Contracts in process consist of the following:
December 31
1998 1997
================================================
Contract costs and
estimated profits $7,989 $6,382
Other costs 485 410
- ------------------------------------------------
8,474 6,792
Less advances and
progress payments 7,522 6,090
- ------------------------------------------------
$ 952 $ 702
================================================
Contract costs include production costs and related overhead, including
general and administrative expenses. Other costs primarily represent amounts
required to be recorded under GAAP that are not currently allocable to
contracts, such as a portion of the company's estimated workers' compensation,
postretirement benefits and environmental expenses. Recovery of these costs
under contracts is considered probable based on existing backlog. If the level
of backlog in the future does not support the continued deferral of these costs,
the profitability of the company's remaining contracts could be affected.
Under the contractual arrangements by which progress payments are received,
the U.S. government asserts that it has a security interest in the contracts in
process identified with the related contracts.
32 GENERAL DYNAMICS 1998 ANNUAL REPORT
14
G. PROPERTY, PLANT AND EQUIPMENT, NET
The major classes of property, plant and equipment are as follows:
December 31
1998 1997
================================================
Land and improvements $ 95 $ 82
Mineral reserves 88 87
Buildings and improvements 323 296
Machinery and equipment 1,120 1,086
Construction in process 100 25
- ------------------------------------------------
1,726 1,576
Less accumulated depreciation,
depletion and amortization 1,028 984
- ------------------------------------------------
$ 698 $ 592
================================================
Certain of the company's plant facilities are provided by the U.S.
government and therefore not included above.
H. INTANGIBLE ASSETS
Intangible assets resulting from the company's acquisitions consist of the
following:
December 31
1998 1997
====================================================
Contracts and programs acquired $ 416 $ 376
Goodwill 1,109 828
- ----------------------------------------------------
$1,525 $1,204
====================================================
Intangible assets are shown net of accumulated amortization of $74 and $31
at December 31, 1998 and 1997, respectively. Intangible assets are amortized on
a straight-line basis over periods ranging from 8 to 40 years.
I. OTHER CURRENT LIABILITIES
Other current liabilities consist of the following:
December 31
1998 1997
================================================
Workers' compensation $ 340 $242
Retirement benefits 196 221
Salaries and wages 84 93
Customer deposits 139 114
Other 347 240
- ------------------------------------------------
$1,106 $910
================================================
J. DEBT
Debt consists of the following:
December 31
1998 1997
=================================================
Senior notes $142 $220
9.95% Debentures -- 38
Industrial development bonds 15 --
Title XI bonds 5 --
Other 7 7
- -------------------------------------------------
169 265
Less current portion 2 108
- -------------------------------------------------
$167 $157
=================================================
On December 31, 1997, the company borrowed in Canadian dollars the U.S.
equivalent of $220 in connection with its acquisition of Computing Devices
International. In April 1998, the company repaid $70 of this note, and in
September 1998, refinanced the balance with a note maturing in 2008. The debt
carries a 6.32 percent interest rate, interest payable semi-annually.
On April 1, 1998, the company exercised its option to call for the early
redemption of all of its outstanding 9.95 percent Debentures.
On November 10, 1998, the company acquired control of NASSCO, which has
several debt obligations. The industrial development bonds are due December 1,
2002, and bear interest at 6.60 percent per annum with interest payable
semi-annually. A sinking fund agreement exists for the partial repayment of
these bonds and requires the company to make deposits semi-annually until
maturity. As the company has prepaid its deposit requirements, the company is
not required to make additional deposits until 2000.
The Title XI bonds are obligations incurred for capital and technology
improvements under a loan guaranteed by the expanded Title XI program of the
National Defense Authorization Act for Fiscal Year 1994. Principal and interest
are payable quarterly through 2001. The interest rate varies based on the
prevailing LIBOR rate.
The company has the capacity to borrow up to $450 under its domestic
committed lines of credit. Of this amount, $50 is available under a credit
facility expiring in June 2000 and $400 is available under a line of credit
expiring in December 2002. International credit arrangements include a credit
facility of approximately $35 expiring in August 1999. There were no material
borrowings under the company's lines of credit during 1998 or 1997.
GENERAL DYNAMICS 1998 ANNUAL REPORT 33
15
K. OTHER LIABILITIES
Other liabilities consist of the following:
December 31
1998 1997
====================================================
Accrued costs on disposed businesses $177 $211
Retirement benefits 183 154
Coal mining related liabilities 73 78
Other 210 185
- ----------------------------------------------------
$643 $628
====================================================
The company has recorded liabilities for contingencies related to disposed
businesses. These liabilities include postretirement benefits, environmental,
legal and other costs.
The company has certain liabilities which are specific to the coal mining
industry, including workers' compensation and reclamation. The company is
subject to the Federal Coal Mine Health & Safety Act of 1969, as amended, and
the related workers' compensation laws in the states in which it has operated.
These laws require the company to pay benefits for occupational disability
resulting from coal workers' pneumoconiosis (black lung). The liability for
known claims and an actuarially determined estimate of future claims that will
be awarded to current and former employees is discounted based on the current
rate. Liabilities to reclaim land disturbed by the mining process and to
perform other closing functions are recorded over the estimated production
lives of the mines.
L. SHAREHOLDERS' EQUITY
STOCK SPLIT. On March 4, 1998, the company's board of directors authorized a
two-for-one stock split effected in the form of a 100 percent stock dividend,
which was distributed on April 2, 1998, to shareholders of record on March 13,
1998. Shareholders' equity has been restated to give retroactive recognition to
the stock split in prior periods by reclassifying from retained earnings and
surplus to common stock the par value of the additional shares arising from the
split. In addition, all references in the financial statements to number of
shares, per share amounts, stock option data and market prices of the company's
common stock have been restated to give effect to the stock split.
AUTHORIZED STOCK. The authorized capital stock of the company consists of
200 million shares of $1 par value common stock and 50 million shares of $1 par
value preferred stock issuable in series, with the rights, preferences and
limitations of each series to be determined by the board of directors.
SHARES OUTSTANDING. The company had 126,693,542, 125,785,554 and 126,204,358
shares of common stock outstanding as of December 31, 1998, 1997 and 1996,
respectively.
M. FINANCE OPERATIONS
The company owns three liquefied natural gas (LNG) tankers which have been
leased to a nonrelated company. The U.S. government-guaranteed Title XI Bonds,
which financed the leases, were retired in 1996. This retirement was financed by
the private placement of new bonds that are secured by the LNG tankers. The new
bonds are callable under certain conditions and are nonrecourse to the company.
Accordingly, in the event the lessee defaults on the lease payments, the company
is not obligated to repay the debt. The 1996 refinancing did not have a material
impact on the company's results of operations or financial condition.
The following is a summary of the comparative financial statements for the
LNG tanker finance operations:
BALANCE SHEET DATA
DECEMBER 31
1998 1997
======================================================
ASSETS
Leases receivable $193 $204
Due from parent 40 52
- ------------------------------------------------------
$233 $256
- ------------------------------------------------------
LIABILITIES AND SHAREHOLDER'S EQUITY
Debt $100 $118
Income taxes 66 70
Shareholder's equity 67 68
- ------------------------------------------------------
$233 $256
======================================================
EARNINGS DATA
Year Ended December 31
1998 1997 1996
=================================================
Interest income $20 $21 $23
Interest expense 7 9 10
Income taxes and other 4 3 7
- -------------------------------------------------
Net earnings $ 9 $ 9 $ 6
=================================================
On October 1, 1995, the leases were extended from 2004 through 2009. These
leases are classified as direct financing leases. The lease extension increased
aggregate future minimum lease payments and unearned interest income, but did
not alter the company's net investment in leases receivable.
The components of the company's net investment in the leases receivable are
as follows:
December 31
1998 1997
================================================
Aggregate future minimum
lease payments $287 $318
Unguaranteed residual value 38 38
Less unearned interest income 132 152
- ------------------------------------------------
$193 $204
================================================
The company is scheduled to receive minimum lease payments of $31 annually
in each of the next five years.
Semiannual scheduled payments, sufficient to retire 100 percent of the
aggregate principal amount of the debt, have commenced and will continue
through maturity in 2004. The
34 GENERAL DYNAMICS 1998 ANNUAL REPORT
16
weighted average interest rate on the debt is 6.2 percent. The schedule of
principal payments for the next five years is $19 in 1999, $19 in 2000, $21 in
2001, $22 in 2002 and $18 in 2003.
NASSCO Funding Corporation, discussed in Note C, is a special purpose
corporation in the business of issuing commercial paper to assist in providing
funding for the Capital Construction Fund (CCF) (see Note N). The shares
invested in the CCF collateralize these commercial paper obligations. The
maximum maturity period on the commercial paper is 60 days. Certain covenants of
the commercial paper agreement require that 95 percent of the CCF be invested in
high-grade government backed mortgage securities.
In addition, on December 31, 1998, NASSCO Funding Corporation had a $20
revolving credit agreement (expiring May 1999) with a financial institution
which provides liquidity in the event that new commercial paper cannot be
reissued to replace maturing commercial paper notes. No balance was outstanding
under the agreement at December 31, 1998.
The following is a summary of the financial statements for NASSCO Funding
Corporation:
BALANCE SHEET DATA
December 31
1998
======================================================
ASSETS
Marketable securities $48
- ------------------------------------------------------
LIABILITIES AND SHAREHOLDER'S EQUITY
Commercial paper $40
Shareholder's equity 8
- ------------------------------------------------------
$48
======================================================
No material earnings from NASSCO Funding Corporation are included in the
company's results of operations due to the consummation of the acquisition on
November 10, 1998.
N. FAIR VALUE OF FINANCIAL INSTRUMENTS
The estimated fair values of the company's financial instruments are as follows:
December 31
1998 1997
=================================================================
Carrying Fair Carrying Fair
Amount Value Amount Value
- -----------------------------------------------------------------
Cash and equivalents
and marketable
securities $220 $220 $441 $441
Other available-for-sale
investments 55 55 46 46
Short- and
long-term debt 169 169 265 268
Short- and long-term
debt--finance
operations 140 144 118 120
- -----------------------------------------------------------------
Fair value is based on quoted market prices, except for privately placed
debt where fair value is based on risk-adjusted discount rates.
Marketable securities classified as available-for-sale were $48 and $30 at
December 31, 1998 and 1997, respectively, and included primarily government
backed mortgage and corporate debt securities, respectively. The 1998 balance
collateralizes the CCF. Qualified assets deposited into the CCF are designated
to provide funds for the acquisition, construction or reconstruction of U.S.
flag and U.S. built marine vessels.
Such deposits are not subject to federal income taxes in the year the
associated revenue is earned, but are taxable with interest payable from the
year of the deposit for the most recent qualified activity, if withdrawn for
general corporate purposes or other nonqualified purposes or upon termination
of the agreement. Deposits into the CCF are preference items for inclusion in
federal alternative minimum taxable income.
Deposits into the CCF not committed for qualified vessels within 25 years
from the date of deposit will be treated as nonqualified withdrawals. Any income
relating to a nonqualified withdrawal is likely to be taxable in the year of
withdrawal.
At December 31, 1998, the CCF was funded by the marketable securities
discussed above and qualified accounts receivable of an affiliate of
approximately $37. The assets designated for the CCF are restricted.
Other available-for-sale investments at December 31, 1998 and 1997 consist
primarily of $46 of U.S. government debt obligations restricted for payment of
workers' compensation benefits under an agreement with the State of Maine. Also
included at December 31, 1998, are $5, primarily in municipal securities,
restricted for repayment of the industrial development bonds discussed in Note
J, and $4 in equity securities restricted for the payment of supplemental
retirement obligations discussed in Note R. Amortized cost for
available-for-sale marketable securities and other investments approximated fair
value at December 31, 1998 and 1997. For debt and equity securities and
obligations classified as other available-for-sale investments at December 31,
1998, $11 mature within one year, $22 between one and five years, $13 between
five and ten years and $9 had no fixed maturity date.
The proceeds from the sale of available-for-sale securities were $274, $612
and $228 in 1998, 1997 and 1996, respectively.
The company was contingently liable for debt and lease guarantees and other
arrangements aggregating up to a maximum of approximately $35 at December 31,
1998. The company knows of no event of default which would require it to satisfy
these guarantees and, therefore, the fair value of these contingent liabilities
is considered immaterial.
O. COMMITMENTS AND CONTINGENCIES
LITIGATION. Claims made by and against the company regarding its consolidated
federal income tax returns are discussed in Notes
GENERAL DYNAMICS 1998 ANNUAL REPORT 35
17
B and E. Claims made by and against the company regarding the development of
the Navy's A-12 aircraft are discussed in Note P.
On April 19, 1995, 101 then-current and former employees of General Dynamics'
Convair Division in San Diego, California filed a six-count complaint in the
Superior Court of California, County of San Diego, styled Argo, et al. v.
General Dynamics, et al. In addition to General Dynamics, four of Convair's
then-current or former managers were also named as defendants. The plaintiffs
alleged that the company interfered with their right to join an earlier class
action lawsuit by, among other things, concealing its plans to close the Convair
Division. On May 1, 1997, a jury rendered a verdict of $101 against the company
and one of the defendants in favor of 97 of the plaintiffs. The jury awarded the
plaintiffs a total of $1.8 in actual damages and $99 in punitive damages. The
company and one of the defendants have appealed the judgment to the Court of
Appeals of the State of California, Fourth Appellate District, Division One. On
appeal, the company is seeking to have the judgment overturned in its entirety
or, alternatively, a substantial reduction in the jury's punitive damage award.
The company believes it has substantial legal defenses, but in any case, it
believes the punitive damage award is excessive as a matter of law. Management
currently believes the ultimate outcome will not have a material impact on the
company's results of operations or financial condition.
On July 13, 1995, General Dynamics Corporation was named as a defendant in a
complaint filed in the Circuit Court of St. Louis County, Missouri, titled Hunt,
et al. v. General Dynamics Corporation, et al. The complaint also names two
insurance brokers, Lloyd Thompson, Ltd. and Willis Caroon Corporation of
Missouri, as defendants. The plaintiffs are members of certain Lloyds' of London
syndicates and British insurance companies who sold the company excess loss
insurance policies covering the company's self-insured workers' compensation
program at Electric Boat for four policy years, from July 1, 1988, to June 30,
1992. The plaintiffs allege that when procuring the policies the company and its
brokers made misrepresentations to the plaintiffs and failed to disclose facts
which were material to the risk. The plaintiffs also allege that the company has
been negligent in its administration of workers' compensation claims. The
plaintiffs seek rescission of the policies, a declaratory judgment that the
policies are void, and compensatory damages in an unspecified amount. General
Dynamics has counterclaimed, alleging that the plaintiffs have breached their
insurance contracts by failing to pay claims. General Dynamics seeks a
declaratory judgment that the policies are valid, actual damages and payment of
a penalty under a Missouri statute for the plaintiffs' vexatious and
unreasonable failure to pay claims. The company does not expect that this case
will have a material impact on the company's results of operations or financial
conditions.
On August 16, 1996, plaintiffs HE Holdings, Inc., and Hughes Missile Systems
Company filed an action against General Dynamics Corporation in the Superior
Court for the State of California for the County of Los Angeles. In June 1998,
plaintiffs filed a sixth amended complaint in which plaintiffs were redesignated
as HE Holdings, Inc., now known as Raytheon Company and Hughes Missile Systems
Company, now known as Raytheon Missile Systems Company ("plaintiffs"). On
September 8, 1998, plaintiffs filed a seventh amended complaint which is now
pending. The seventh amended complaint alleges breach of contract, tortious
interference with contract, conversion, fraud and breach of the implied covenant
of good faith and fair dealing, all with respect to the Asset Purchase Agreement
dated May 8, 1992, for the sale of the company's missile business, various
related leases and other alleged agreements. The seventh amended complaint seeks
approximately $25 in compensatory damages, as well as punitive damages and
declaratory relief. The company does not expect that the lawsuit will have a
material impact on the company's results of operations or financial condition.
The company is either a named defendant or a third-party defendant in
certain multi-plaintiff tort cases pending in Tucson, Arizona, captioned:
Cordova, et al. v. Hughes Aircraft Co., et al.; Lanier, et al. v. Hughes
Aircraft Co., et al.; Yslava, et al. v. Hughes Aircraft Co.; and Arellano, et
al. v. Hughes Aircraft Co. The first case was filed in Superior Court for Pima
County, Arizona. The remaining cases are pending in federal district court in
Arizona. In all four cases the plaintiffs allege that they suffered personal
injuries and/or property damage from chronic exposure to drinking water alleged
to be contaminated with trace amounts of the industrial solvent
trichloroethylene. The alleged source of the contamination was industrial
facilities in and around the site now occupied by the Tucson International
Airport (TIA) and U.S. Air Force Plant #44. In addition to the company,
defendants are Hughes Aircraft Co. (now Raytheon), the Tucson Airport authority
(TAA), the City of Tucson (the City) and McDonnell Douglas Corp. (MDC). The
company does not believe that these lawsuits will have a material impact on the
company's results of operations or financial condition.
In other litigation concerning the Tucson site, the company is a defendant
in two cases brought in federal district court in Arizona by TAA and the City
under the Comprehensive Environmental Response Compensation and Liability Act
(CERCLA). Plaintiffs seek reimbursement of CERCLA response costs and a
declaration of the company's alleged liability with respect to soil and
groundwater contamination at portions of the Tucson site. On September 30,
1998, the U.S. Environmental Protection Agency (U.S. EPA) issued a Special
Notice Letter notifying the company that it was a potentially responsible party
(PRP) with respect to contamination of soil and shallow groundwater on and near
property currently occupied by the TIA. Other PRPs receiving a similar notice
were the U.S. Air Force, TAA, MDC and the City. The company has reached an
agreement to settle the litigation brought by TAA and the City and is
negotiating a potential consent decree with the U.S. EPA in response to the
Special Notice Letter. The company does not believe that these lawsuits or the
U.S. EPA's
36 GENERAL DYNAMICS 1998 ANNUAL REPORT
18
notice of potential liability will have a material impact on the company's
results of operations or financial condition.
The company is also a defendant in other lawsuits and claims and in other
investigations of varying nature. The company believes its liabilities in these
proceedings, in the aggregate, are not material to the company's results of
operations or financial condition.
ENVIRONMENTAL. The company is directly or indirectly involved in certain
Superfund sites in which the company, along with other major U.S. corporations,
has been designated a PRP by the U.S. Environmental Protection Agency or a state
environmental agency with respect to past shipments of hazardous waste to sites
now requiring environmental cleanup. Based on a site by site analysis of the
estimated quantity of waste contributed by the company relative to the estimated
total quantity of waste, the company believes its liability at any individual
site is not material. The company is also involved in the investigation, cleanup
and remediation of various conditions at sites it currently or formerly owned or
operated.
The company measures its environmental exposure based on enacted laws and
existing regulations and on the technology expected to be approved to complete
the remediation effort. The estimated cost to perform each of the elements of
the remediation effort is based on when those elements are expected to be
performed. Where a reasonable basis for apportionment exists with other PRPs,
the company estimates only its allowable share of the joint and several
remediation liability for a site, taking into consideration the solvency of
other participating PRPs. Based on a site by site analysis, the company believes
it has adequate accruals for any liability it may incur arising from sites
currently or formerly owned or operated at which there is a known environmental
condition, or Superfund site at which the company is a PRP.
OTHER. In the ordinary course of business, the company has entered into
letter of credit arrangements and other arrangements with financial institutions
and insurance carriers aggregating approximately $410 at December 31, 1998. For
discussion of other financial guarantees, see Note N. The company's rental
commitments under existing operating leases at December 31, 1998, are not
significant.
P. TERMINATION OF A-12 PROGRAM
The A-12 contract was a fixed-price incentive contract for the full-scale
development and initial production of the Navy's new carrier-based Advanced
Tactical Aircraft. The Navy terminated the company's A-12 aircraft contract for
default. Both the company and McDonnell Douglas, now owned by the Boeing
Company, (the contractors) were parties to the contract with the Navy, each had
full responsibility to the Navy for performance under the contract, and both are
jointly and severally liable for potential liabilities arising from the
termination. As a consequence of the termination for default, the Navy demanded
that the contractors repay $1,352 in unliquidated progress payments, but agreed
to defer collection of the amount pending a decision by the U.S. Court of
Federal Claims on the contractors' appeal of the termination for default, or a
negotiated settlement.
The contractors filed a complaint on June 7, 1991, in the U.S. Court of
Federal Claims contesting the default termination. The suit, in effect, seeks to
convert the termination for default to a termination for convenience of the U.S.
government and seeks other legal relief. A trial on Count XVII of the complaint,
which relates to the propriety of the process used in terminating the contract
for default, was concluded in October 1993. In December 1994, the court issued
an order vacating the termination for default. On December 19, 1995, following
further proceedings, the court issued an order converting the termination for
default to a termination for convenience.
On February 23, 1998, a final judgment was entered in favor of the
contractors for $1,200 plus interest. The U.S. government filed an appeal in
the U.S. Court of Appeals for the Federal Circuit. The U.S. government seeks
reversal of the judgment and a remand to the trial court for a full trial on
the merits. The appeal has been briefed and argued. Final resolution of the
A-12 litigation will depend on the outcome of the appeal and further
proceedings in the trial court, if any. The company has not recognized any
claim revenue from the Navy.
The company has fully reserved the contracts in process balance associated
with the A-12 program and has accrued the company's estimated termination
liabilities, and the liability associated with pursuing the litigation through
the appeals process. In the unlikely event that the court's decision converting
the termination to a termination for convenience is reversed on appeal and the
contractors are ultimately found to be in default of the A-12 contract and are
required to repay all unliquidated progress payments, additional losses of
approximately $675, plus interest, may be recognized by the company. The company
believes the possibility of this result is remote.
Q. INCENTIVE COMPENSATION PLAN
Under the 1997 Incentive Compensation Plan, the company may grant awards in
combination of cash, common stock, stock options and restricted stock. The plan
complies with the Securities and Exchange Commission's Rule 16b-3 and with the
Internal Revenue Code Section 162(m).
In October 1993, the company introduced a long-term incentive program which
granted stock options and restricted stock. The stock options are exercisable at
the fair market value of the common stock on the date of grant generally with 50
percent of the stock options vesting on the one-year anniversary of their grant
and the remaining 50 percent vesting on the two-year anniversary of their grant.
The stock options have a maximum term of five years. The restricted stock has a
feature that will increase or decrease the number of shares initially granted
based on movement in the company's stock price from the date of grant to the end
of a specific performance period (generally 18 to 24 months). Once the number
GENERAL DYNAMICS 1998 ANNUAL REPORT 37
19
granted has been adjusted, restrictions will continue to be imposed for an
additional two years, at which time all restrictions will lapse. Prior to
October 1993, stock options granted under the company's incentive compensation
plans were awarded for a maximum term of ten years and were exercisable in their
entirety beginning 18 months after the date of award.
There were 507,340, 345,860 and 91,546 shares of restricted stock awarded
in 1998, 1997 and 1996, respectively. There were 1,219,535 shares of restricted
stock outstanding at December 31, 1998. Information with respect to stock
options is as follows:
Year Ended December 31
1998 1997 1996
================================================================================
NUMBER OF SHARES
UNDER STOCK OPTIONS:
Outstanding at
beginning of year 3,577,308 3,653,704 4,605,446
Granted 1,435,640 1,344,252 137,600
Exercised (1,231,376) (1,272,382) (990,010)
Canceled (48,541) (148,266) (99,332)
- --------------------------------------------------------------------------------
Outstanding at end
of year 3,733,031 3,577,308 3,653,704
- --------------------------------------------------------------------------------
EXERCISABLE AT END
OF YEAR 1,675,562 1,602,766 2,858,744
- --------------------------------------------------------------------------------
WEIGHTED AVERAGE
EXERCISE PRICE:
Outstanding at
beginning of year $28.76 $25.74 $22.84
Granted 43.30 33.17 30.40
Exercised 25.48 24.55 12.60
Canceled 36.81 30.45 29.02
Outstanding at end
of year 35.33 28.76 25.74
Exercisable at end
of year 29.41 24.53 24.49
- --------------------------------------------------------------------------------
Information with respect to stock options outstanding and stock options
exercisable at December 31, 1998, is as follows:
Options Outstanding
-------------------------------------------------
Weighted
Average Weighted
Number Remaining Average
Range of Outstanding Contractual Exercise
Exercise Prices at 12/31/98 Life Price
================================================================================
$ 3.79-11.37 56,376 2.9 years $ 8.21
19.91-23.27 245,036 .4 22.89
29.06-33.38 2,004,543 2.7 31.96
36.50-46.84 1,427,076 4.2 43.28
- --------------------------------------------------------------------------------
3,733,031
- --------------------------------------------------------------------------------
Options Exercisable
-------------------------------------------------
Weighted
Average Weighted
Number Remaining Average
Range of Outstanding Contractual Exercise
Exercise Prices at 12/31/98 Life Price
================================================================================
$ 3.79-11.37 56,376 2.9 years $ 8.21
19.91-23.27 245,036 .4 22.89
29.06-33.38 1,370,000 2.4 31.42
36.50-46.84 4,150 3.5 39.96
- --------------------------------------------------------------------------------
1,675,562
- --------------------------------------------------------------------------------
At December 31, 1998, 6,071,881 treasury shares have been reserved for
options that may be granted in the future, in addition to the shares reserved
for issuance on the exercise of options outstanding.
Had compensation cost for stock options been determined based on the fair
value at the grant dates for awards under the company's incentive compensation
plans, the company's net earnings and net earnings per share would have been
reduced to the pro forma amounts indicated as follows:
1998 1997 1996
================================================================================
Net Earnings: As Reported $364 $316 $270
Pro Forma 359 312 268
Net Earnings Per
Share--Basic: As Reported $2.88 $2.51 $2.14
Pro Forma 2.84 2.49 2.12
Net Earnings Per
Share--Diluted: As Reported $2.86 $2.50 $2.13
Pro Forma 2.82 2.47 2.11
- --------------------------------------------------------------------------------
Weighted average fair
value of options granted $7.63 $5.42 $3.77
- --------------------------------------------------------------------------------
The compensation cost calculated under the fair value approach shown above
is recognized over the vesting period of the stock options.
The fair value is estimated on the date of grant using the Black-Scholes
option pricing model with the following weighted average assumptions used for
grants:
1998 1997 1996
================================================================================
Dividend yield 1.9% 2.5% 2.3%
Expected volatility 17.6% 18.0% 20.0%
Risk-free interest rate 5.6% 6.4% 5.7%
Expected lives after
vesting period 24 18 4
months months months
- --------------------------------------------------------------------------------
R. RETIREMENT PLANS
PENSION. The company has 14 trusteed, noncontributory, qualified defined benefit
pension plans covering substantially all employees. Under certain of the plans,
benefits are primarily a function of both the employee's years of service and
level of
38 GENERAL DYNAMICS 1998 ANNUAL REPORT
20
compensation, while under other plans, benefits are a function primarily of
years of service.
It is the company's policy to fund the plans to the maximum extent
deductible under existing federal income tax regulations. Such contributions are
intended to provide not only for benefits attributed to service to date, but
also for those expected to be earned in the future.
The change in the company's benefit obligation is as follows:
Year Ended December 31
1998 1997 1996
================================================================================
Benefit obligation at
beginning of year $(3,339) $(2,597) $(2,649)
Service cost (63) (52) (50)
Interest cost (233) (210) (182)
Amendments (57) (28) (12)
Actuarial gain (loss) (211) (95) 165
Acquisitions (69) (526) (22)
Benefits paid 203 169 153
- --------------------------------------------------------------------------------
Benefit obligation at
end of year $(3,769) $(3,339) $(2,597)
- --------------------------------------------------------------------------------
The following tables set forth the company's change in plan assets:
Year Ended December 31
1998 1997 1996
================================================================================
Fair value of plan assets
at beginning of year $4,491 $3,356 $3,441
Actual return on plan
assets 873 741 12
Acquisitions 29 545 35
Employer contributions 33 18 21
Benefits paid (203) (169) (153)
- --------------------------------------------------------------------------------
Fair value of plan assets
at end of year $5,223 $4,491 $3,356
- --------------------------------------------------------------------------------
December 31
1998 1997 1996
================================================================================
Funded status $1,454 $1,152 $759
Unrecognized net
actuarial gain (1,262) (919) (550)
Unrecognized prior
service cost 250 253 240
Unrecognized transition
asset (24) (35) (39)
- --------------------------------------------------------------------------------
Prepaid pension cost $ 418 $ 451 $410
- --------------------------------------------------------------------------------
Assumptions used in accounting for the plans are as follows:
Year Ended December 31
1998 1997 1996
================================================================================
Discount rate 6.75% 7.25% 7.5%
Varying rates of increase
in compensation
levels based on age 4.5-10% 4.5-10% 4.5-10%
Expected long-term
rate of return
on assets 8.0% 8.0% 8.0%
- --------------------------------------------------------------------------------
Net periodic pension cost for the total company included the following:
Year Ended December 31
1998 1997 1996
- --------------------------------------------------------------------------------
Service cost $ 63 $ 52 $ 50
Interest cost 233 210 182
Expected return on
plan assets (309) (272) (247)
Recognized net
actuarial (gain) loss (10) (8) 8
Amortization of
unrecognized
transition asset (8) (8) (8)
Amortization of prior
service cost 27 25 23
- --------------------------------------------------------------------------------
$ (4) $ (1) $ 8
- --------------------------------------------------------------------------------
Under SFAS No. 87, "Employers' Accounting for Pensions," the company is
required to assume a discount rate at which the obligation could be currently
settled. Reflecting the movement in interest rates, the company decreased its
discount rate assumption from 7.25 percent to 6.75 percent at December 31, 1998,
which increased the projected benefit obligation $210.
Changes in prior service cost resulting from plan amendments are amortized
on a straight-line basis over the average remaining service period of employees
expected to receive benefits under the plan.
Included in the company's prepaid pension cost is a net asset of $149 and
$136 at December 31, 1998 and 1997, respectively, related to the company's
commercial pension plan. The commercial prepaid pension cost is included in
other noncurrent assets on the Consolidated Balance Sheet.
The company's contractual arrangements with the U.S. government provide for
the recovery of contributions to the company's government plans. Historically,
the amount contributed to these plans, charged to contracts and included in net
sales has exceeded the net periodic pension cost included in operating costs and
expenses as determined under SFAS 87. Therefore, the company has deferred
recognition of earnings resulting from the difference between contributions
GENERAL DYNAMICS 1998 ANNUAL REPORT 39
21
and net periodic pension cost to provide better matching of revenues and
expenses. Similarly, pension settlements and curtailments under the government
plans have also been deferred. As the U.S. government will receive an equitable
interest in the excess assets of a government pension plan in the event of plan
termination, the aforementioned deferrals have been classified against the
prepaid pension cost related to the government plans resulting in the
recognition of no net asset on the Consolidated Balance Sheet.
At December 31, 1998, approximately 55 percent of the plans' assets are
invested in securities of the U.S. government or its agencies, 30 percent in
diversified U.S. common stocks, 12 percent in mortgage-backed securities and 3
percent in diversified U.S. corporate debt securities.
In addition to the qualified defined benefit plans, the company provides
eligible employees the opportunity to participate in defined contribution
savings plans that permit contributions on both a pretax and after-tax basis.
Generally, salaried employees and certain hourly employees are eligible to
participate upon commencement of employment with the company. Under most plans,
the employee may contribute to various investment alternatives, including
investment in the company's common stock. In certain of the plans, the company
matches a portion of the employees' contributions with contributions to a fund
which invests in the company's common stock. The company's contributions to the
defined contribution plans amounted to $37, $27 and $22 in 1998, 1997 and 1996,
respectively. The increase in 1998 over 1997 contributions is primarily
attributable to the acquisitions discussed in Note C. Approximately 13 and 12
million shares of the company's common stock were held by the defined
contribution plans at December 31, 1998 and 1997, respectively.
The company also sponsors several unfunded non-qualified supplemental
executive plans that provide participants with additional benefits, including
any excess of such benefits over limits imposed on qualified plans by federal
law. The recorded liability and expense related to these plans are not material
to the company's results of operations and financial condition.
OTHER POSTRETIREMENT BENEFITS. The company maintains plans providing
postretirement health care coverage for many of its current and former
employees. Postretirement life insurance benefits are also provided to certain
retirees. These benefits vary by employment status, age, service and salary
level at retirement. The coverage provided and the extent to which the retirees
share in the cost of the program vary throughout the company. Both health and
life insurance benefits are provided only to those employees who retire directly
from the service of the company and not to those who terminate service/seniority
prior to eligibility for retirement.
The company established and began funding a Voluntary Employee's
Beneficiary Association (VEBA) trust in 1992 for certain plans in an amount
approximately equal to their related annual net periodic postretirement benefit
cost. The remaining plans are primarily funded as claims are received.
The change in the company's benefit obligation is as follows:
Year Ended December 31
1998 1997 1996
================================================================================
Benefit obligation at
beginning of year $(620) $(628) $(688)
Service cost (4) (4) (7)
Interest cost (43) (44) (46)
Amendments 36 66 (1)
Actuarial gain (loss) (43) (5) 65
Acquisitions (13) (59) (2)
Benefits paid 52 54 51
- --------------------------------------------------------------------------------
Benefit obligation at
end of year $(635) $(620) $(628)
- --------------------------------------------------------------------------------
The following tables set forth the company's change in trust assets:
Year Ended December 31
1998 1997 1996
================================================================================
Fair value of trust assets
at beginning of year $241 $203 $179
Actual return on
trust assets 48 43 17
Employer contributions 17 20 30
Benefits paid (25) (25) (23)
- --------------------------------------------------------------------------------
Fair value of trust assets
at end of year $281 $241 $203
- --------------------------------------------------------------------------------
December 31
1998 1997 1996
================================================================================
Funded status $(354) $(379) $(425)
Unrecognized net
actuarial gain (65) (76) (56)
Unrecognized prior
service cost 2 3 3
Unrecognized
transition obligation 71 130 217
- --------------------------------------------------------------------------------
Accrued postretirement
benefit cost $(346) $(322) $(261)
- --------------------------------------------------------------------------------
40 GENERAL DYNAMICS 1998 ANNUAL REPORT
22
Assumptions used in accounting for the plans are as follows:
Year Ended December 31
1998 1997 1996
================================================================================
Discount rate 6.75% 7.25% 7.5%
Expected long-term
rate of return on assets 8% 8% 8%
Assumed health care
cost trend rate
for next year:
Post-65 claim groups 4.5% 5% 6%
Pre-65 claim groups 6.5% 7.5% 8.5%
- --------------------------------------------------------------------------------
Net periodic postretirement benefit cost for the total company included the
following:
Year Ended December 31
1998 1997 1996
================================================================================
Service cost $ 4 $ 4 $ 7
Interest cost 43 44 46
Expected return
on trust assets (16) (14) (13)
Recognized net
actuarial gain (4) (3) (1)
Amortization of
unrecognized
transition obligation 23 24 29
Amortization of prior
service cost -- -- 1
- --------------------------------------------------------------------------------
$ 50 $ 55 $ 69
- --------------------------------------------------------------------------------
As previously stated, the company decreased its discount rate assumption
from 7.25 percent to 6.75 percent at December 31, 1998, which increased the
accumulated postretirement benefit obligation $32.
The health care cost trend rates are assumed to gradually decline to 4.5
percent and 5 percent for post-65 and pre-65 claim groups, respectively, in the
year 2002 and thereafter over the projected payout period of the benefits.
Assumed health care cost trend rates have a significant effect on the
amounts reported for the health care plans. A one-percentage-point change in
assumed health care cost trend rates would have the following effects:
1-Percentage- 1-Percentage-
Point Increase Point Decrease
================================================================================
Effect on total of
service and interest
cost components $ 3 $ (3)
Effect on accumulated
postretirement benefit
obligation $47 $(40)
- --------------------------------------------------------------------------------
At December 31, 1998, approximately 57 percent of the trusts' assets were
invested in diversified U.S. common stocks, 5 percent in mortgage-backed
securities, 25 percent in securities of the U.S. government and its agencies and
13 percent in diversified U.S. corporate debt securities.
The company's contractual arrangements with the U.S. government provide for
the recovery of contributions to a VEBA, and for non-funded plans, for costs
based on claims paid. The net periodic postretirement benefit cost exceeds the
company's cost currently allocable to contracts. To the extent the company has
contracts in backlog sufficient to recover the excess cost, the company is
deferring the charge in contracts in process until such time that the cost is
allocable to contracts.
GENERAL DYNAMICS 1998 ANNUAL REPORT 41
23
S. BUSINESS SEGMENT INFORMATION
The company's primary business is supplying sophisticated defense systems to the
United States and its allies. Management has chosen to organize its business
segments in accordance with several factors, including a combination of the
nature of products and services offered, the nature of the production processes
and the class of customer for the company's products. Operating segments are
aggregated for reporting purposes consistent with these criteria. Management
measures its segments' profit based primarily on operating earnings. As such,
net interest and other income items have not been allocated to the company's
segments. For a further description of the company's business segments, see
Management's Discussion and Analysis of the Results of Operations and Financial
Condition.
Summary financial information for each of the company's segments follows:
Net Sales Operating Earnings Sales to U.S. Government
1998 1997 1996 1998 1997 1996 1998 1997 1996
===============================================================================================================================
Marine Systems $2,666 $2,311 $2,332 $285 $234 $216 $2,645 $2,280 $2,316
Combat Systems 1,272 1,509 1,026 166 187 140 1,165 1,371 996
Information Systems
& Technology 796 -- -- 59 -- -- 351 -- --
Other 236 242 223 32 25 (3) -- -- --
- -------------------------------------------------------------------------------------------------------------------------------
$4,970 $4,062 $3,581 $542 $446 $353 $4,161 $3,651 $3,312
- -------------------------------------------------------------------------------------------------------------------------------
Depreciation, Depletion
Identifiable Assets Capital Expenditures and Amortization
1998 1997 1996 1998 1997 1996 1998 1997 1996
===================================================================================================================
Marine Systems $1,421 $ 706 $ 806 $ 79 $28 $18 $ 40 $34 $40
Combat Systems 923 974 336 18 17 14 27 36 12
Information Systems
& Technology 1,095 1,075 -- 15 -- -- 40 -- --
Other 406 371 388 16 19 12 15 17 12
Corporate* 727 965 1,769 30 19 31 4 4 3
- -------------------------------------------------------------------------------------------------------------------
$4,572 $4,091 $3,299 $158 $83 $75 $126 $91 $67
- -------------------------------------------------------------------------------------------------------------------
*Corporate identifiable assets include cash and equivalents and marketable
securities, deferred taxes, real estate held for development and prepaid
pension cost.
T. QUARTERLY DATA (UNAUDITED)
Common Stock
--------------------------------------------
Net Earnings Market Price
Per Share Range
Net Operating Net --------------------- ----------------------------- Dividends
Sales Earnings Earnings Basic Diluted High Low Declared
========================================================================================================================
1998
4th Quarter $1,466 $147 $96 $.76 $.75 $62 $49 1/4 $.22
3rd Quarter 1,172 136 94 .74 .74 55 42 7/8 .22
2nd Quarter 1,178 135 92 .73 .72 48 3/8 40 1/4 .22
1st Quarter 1,154 124 82 .65 .65 45 3/4 41 25/32 .22
1997
4th Quarter $1,101 $117 $83 $.66 $.65 $44 7/16 $37 31/32 $.205
3rd Quarter 988 113 82 .65 .65 45 3/4 37 .205
2nd Quarter 1,032 114 80 .64 .64 38 15/16 31 9/16 .205
1st Quarter 941 102 71 .56 .56 36 1/8 32 13/16 .205
- ------------------------------------------------------------------------------------------------------------------------
Note: Quarterly data is based on a 13 week period.
42 GENERAL DYNAMICS 1998 ANNUAL REPORT
24
STATEMENT OF FINANCIAL RESPONSIBILITY
To the Shareholders of General Dynamics Corporation:
The management of General Dynamics Corporation is responsible for the
consolidated financial statements and all related financial information
contained in this report. The financial statements, which include amounts based
on estimates and judgments, have been prepared in accordance with generally
accepted accounting principles applied on a consistent basis.
The company maintains a system of internal accounting controls designed and
intended to provide reasonable assurance that assets are safeguarded, that
transactions are executed and recorded in accordance with management's
authorization and that accountability for assets is maintained. An environment
that establishes an appropriate level of control consciousness is maintained and
monitored by management. An important element of the monitoring process is an
internal audit program that independently assesses the effectiveness of the
control environment.
The Audit and Corporate Responsibility Committee of the board of directors,
which is composed of four outside directors, meets periodically and, when
appropriate, separately with the independent auditors, management and internal
audit to review the activities of each.
The financial statements have been audited by Arthur Andersen LLP,
independent public accountants, whose report follows.
/s/ MICHAEL J. MANCUSO /s/ JOHN W. SCHWARTZ
Michael J. Mancuso John W. Schwartz
Senior Vice President and Chief Financial Officer Vice President and Controller
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To General Dynamics Corporation:
We have audited the accompanying Consolidated Balance Sheet of General Dynamics
Corporation (a Delaware corporation) and subsidiaries as of December 31, 1998
and 1997, and the related Consolidated Statements of Earnings, Shareholders'
Equity and Cash Flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of General Dynamics Corporation
and subsidiaries as of December 31, 1998 and 1997, and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
/s/ ARTHUR ANDERSEN LLP
ARTHUR ANDERSEN LLP
Washington, D.C.
March 2, 1999
GENERAL DYNAMICS 1998 ANNUAL REPORT 43
25
SELECTED FINANCIAL DATA (UNAUDITED)
The following table presents summary selected historical financial data derived
from the audited Consolidated Financial Statements and other information of the
company for each of the five years presented. The following information should
be read in conjunction with Management's Discussion and Analysis of the Results
of Operations and Financial Condition and the audited Consolidated Financial
Statements and related Notes thereto.
(DOLLARS IN MILLIONS, EXCEPT PER SHARE AND PER EMPLOYEE AMOUNTS) 1998 1997 1996 1995 1994
==================================================================================================================================
SUMMARY OF OPERATIONS
Net sales $ 4,970 $ 4,062 $ 3,581 $ 3,067 $ 3,058
Operating costs and expenses 4,428 3,616 3,228 2,752 2,737
Interest income, net 4 36 55 55 22
Provision for income taxes 185 163 139 128 120
Earnings from continuing operations 364 316 270 247 223
Earnings per share from continuing
operations--basic 2.88 2.51 2.14 1.96 1.77
Earnings per share from continuing
operations--diluted 2.86 2.50 2.13 1.95 1.76
Cash dividends on common stock .88 .82 .82 .75 .70
Sales per employee 178,600(d) 160,000(c) 155,500 138,200(b) 143,900(a)
- ----------------------------------------------------------------------------------------------------------------------------------
FINANCIAL POSITION AT DECEMBER 31
Cash and equivalents and marketable securities $ 220 $ 441 $ 1,155 $ 1,095 $ 1,059
Property, plant and equipment, net 698 592 441 398 264
Total assets 4,572 4,091 3,299 3,164 2,673
Short- and long-term debt 169 265 38 38 40
Short- and long-term debt--finance operations 140 118 135 146 161
Shareholders' equity 2,219 1,915 1,714 1,567 1,316
Per share 17.51 15.22 13.58 12.39 10.45
- ---------------------------------------------------------------------------------------------------------------------------------
OTHER INFORMATION
Funded backlog $ 7,292 $ 6,796 $ 6,161 $ 5,227 $ 4,562
Total backlog 14,598 9,599 10,350 7,386 6,006
Shares outstanding at December 31
(in millions) 126.7 125.8 126.2 126.5 126.0
Weighted average shares outstanding
basic (in millions) 126.4 125.7 126.3 126.0 126.1
Weighted average shares outstanding
diluted (in millions) 127.2 126.6 126.9 126.5 126.9
Common shareholders of record
at December 31 19,904 21,046 22,129 22,930 23,935
Active employees at December 31:
Total company 30,700 29,000 23,100 27,700 24,200
Excluding discontinued operations 30,700 29,000 23,100 26,800 21,300
- ---------------------------------------------------------------------------------------------------------------------------------
(a) Excludes Bath Iron Works, which was acquired on September 13, 1995.
(b) Includes pro forma results of Bath Iron Works as if owned by the company
for the entire year.
(c) Excludes Advanced Technology Systems, which was acquired on October 1,
1997, and Computing Devices International, which was acquired on December
31, 1997. See Note C.
(d) Excludes NASSCO, which was acquired on November 10, 1998. See Note C.
44 GENERAL DYNAMICS 1998 ANNUAL REPORT