Business Overview

General Dynamics offers a broad portfolio of products and services in business aviation; combat vehicles, weapons systems and munitions; shipbuilding design and construction; and information systems, technologies and services. We operate through four business groups - Aerospace, Combat Systems, Marine Systems, and Information Systems and Technology. Our primary customers are the U.S. military, other U.S. government organizations, the armed forces of other nations, and a diverse base of corporate, government and individual owners of business aircraft. We operate in two primary markets: defense and business aviation. The majority of our revenues derive from contracts with the U.S. military. The following discussion should be read in conjunction with our 2008 Annual Report on Form 10-K, filed with the Securities and Exchange Commission, and with the unaudited Consolidated Financial Statements included in this Form 10-Q.

Results of Operations

Consolidated Overview



                              October 4        September 28
        Three Months Ended      2009               2008               Variance
        Revenues             $     7,719      $        7,140      $   579       8.1 %
        Operating earnings           874                 933          (59 )    (6.3 )%
        Operating margin            11.3 %              13.1 %

                              October 4        September 28
        Nine Months Ended       2009               2008               Variance
        Revenues             $    24,083      $       21,448      $ 2,635      12.3 %
        Operating earnings         2,724               2,715            9       0.3 %
        Operating margin            11.3 %              12.7 %

General Dynamics' revenues increased in the third quarter and first nine months of 2009 compared to the same periods in 2008 with strong contributions from each of our defense businesses. The Combat Systems group generated the most significant increase in revenues in the third quarter and first nine months of 2009 as a result of higher volume in its U.S. and European military vehicle programs and the acquisition of AxleTech International in December 2008. In Marine Systems, increases in shipbuilding and repair activity at each of the group's shipyards resulted in the tenth consecutive quarterly increase in the group's revenues. Revenues increased in Information Systems and Technology on higher volume in each of the group's U.S. operations as well as recent acquisitions. In the Aerospace group, revenues were down in the third quarter, but remained steady year-to-date compared to 2008. Lower sales of Gulfstream aircraft and reduced aircraft services activity were offset somewhat by the November 2008 acquisition of Jet Aviation.

Our operating earnings decreased in the third quarter but remained steady for the first nine months of 2009 compared to the same periods in 2008. All of our defense businesses generated solid

earnings growth in the three- and nine-month periods compared with 2008. Shifting contract mix in Combat Systems and Information Systems and Technology resulted in margin fluctuation from 2008 to 2009. In Combat Systems, 2009 third-quarter and year-to-date margins were down from historic highs in 2008. Margins in Information Systems and Technology were down year-to-date but improved in the third quarter both year-over-year and sequentially. In Marine Systems, improved operating performance at each of the group's shipyards led to increased margins in the three- and nine-month periods in 2009. The Aerospace group's earnings declined in both periods due to reduced aircraft deliveries and some losses associated with pre-owned aircraft. These factors, along with the addition of lower-margin business from Jet Aviation, reduced the group's margins significantly in the third quarter and first nine months of 2009. As a result, our overall operating margins decreased by 180 basis points in the third quarter and 140 basis points in the first nine months of 2009.

General and administrative (G&A) expenses as a percentage of sales for the first nine months of 2009 were 6.1 percent compared with 6.0 percent in the same period in 2008. We expect G&A expenses as a percentage of sales for the full-year 2009 to be approximately 6 percent.

Net cash provided by operating activities from continuing operations was $1.4 billion in the first nine months of 2009, compared with $2.3 billion in the same period in 2008. We used our cash to fund acquisitions and capital expenditures, repurchase our common stock, pay dividends and repay maturing debt. Our net debt
- debt less cash and equivalents and marketable securities - was $2.4 billion at the end of the third quarter of 2009 compared with $2.3 billion at the end of 2008. Net debt increased slightly after giving effect to $805 spent on acquisitions, $430 of dividends paid, $397 of company-sponsored research and development, $251 of capital expenditures, more than $250 of contributions to our retirement plans and $109 of share repurchases during the first nine months of the year.

Net interest expense in the first nine months of 2009 increased by $75 to $117 over the same period in 2008 due to the issuance of additional debt in 2008 and 2009 and lower interest income on a reduced invested cash balance. We expect full-year net interest expense of approximately $160.

Our effective tax rate for the nine-month period ended October 4, 2009, was 31.3 percent compared with 30.9 percent in the same period in 2008. The 2008 rate included a $35 - or approximately $0.09 per-share - benefit from the settlement of a tax refund suit, which reduced the tax rate for the first nine months of 2008 by 130 basis points. We anticipate an effective tax rate of approximately 31.5 percent for the full-year 2009, compared with 31.2 percent in 2008. For additional discussion of tax matters, see Note I to the unaudited Consolidated Financial Statements.

Our total backlog was $66.2 billion as of October 4, 2009, up 10 percent from a year ago, but down 2 percent from the second quarter. Funded backlog was $46.8 billion at the end of the third quarter, also down 2 percent from the end of the second quarter. The backlog for the Combat Systems and Information Systems and Technology groups increased during the quarter on strong order activity. Our total backlog does not include work awarded under unfunded indefinite delivery, indefinite quantity (IDIQ) contracts, unexercised options associated with existing firm contracts or options to purchase new aircraft, which we refer to collectively as estimated potential contract value. As of the end of the third quarter 2009, management's estimate of this potential contract value, which we expect to realize over the next 10 to 15 years, was approximately $18.2 billion, up 3 percent from $17.7 billion at the end of the second quarter.

Aerospace



                                                October 4         September 28
Three Months Ended                                2009                2008                  Variance
Revenues                                       $     1,120        $       1,372        $ (252 )      (18.4 )%
Operating earnings                                     125                  281          (156 )      (55.5 )%
Operating margin                                      11.2 %               20.5 %
Gulfstream aircraft deliveries (in units):
Green                                                   17                   39           (22 )      (56.4 )%
Outfitted                                               24                   38           (14 )      (36.8 )%

                                                October 4         September 28
Nine Months Ended                                 2009                2008                  Variance
Revenues                                       $     3,990        $       3,980        $   10          0.3 %
Operating earnings                                     540                  757          (217 )      (28.7 )%
Operating margin                                      13.5 %               19.0 %
Gulfstream aircraft deliveries (in units):
Green                                                   74                  115           (41 )      (35.7 )%
Outfitted                                               89                  114           (25 )      (21.9 )%

The Aerospace group's revenues were down in the third quarter of 2009 but remained steady in the first nine months of the year compared to the same prior-year periods. These results reflect the net effect of a significant decline in Gulfstream revenues - 39 percent in the third quarter and 22 percent in the first nine months of the year - and the addition of Jet Aviation, acquired in the fourth quarter of 2008.

Starting in late 2008, the business-jet market was disrupted by the global economic crisis and the resulting tightening of credit markets. In response to these conditions, we scaled back Gulfstream's aircraft production and delivery schedule to bridge the market downturn, including a planned five-week workforce furlough in the months of July and August. As a result, aircraft-manufacturing revenues were down 46 percent in the third quarter and 25 percent in the first nine months of 2009 compared with the prior year. The group's aircraft-services business has also felt the effects of the market dislocation, as customers have deferred optional aircraft maintenance activities and price competition has intensified. As a result, organic aircraft-services revenues were down 22 percent in the third quarter and 17 percent year-to-date in 2009. Pre-owned aircraft revenues increased in 2009, slightly offsetting the decline in manufacturing and services revenues. The group sold five pre-owned aircraft for $119 in the first nine months of 2009 compared with two sales for $17 in the same period in 2008.

Driven largely by the factors noted above, the group's operating earnings for the third quarter and first nine months of 2009 decreased compared to the prior-year periods. The net reduction in earnings consisted of the following factors:

                                               Third Quarter        Nine Months
     Aircraft manufacturing and completions   $          (123 )    $        (105 )
     Pre-owned aircraft                                   (10 )              (35 )
     Aircraft services                                     (8 )               (7 )
     Other                                                (15 )              (70 )
     Total decrease in operating earnings     $          (156 )    $        (217 )

Aircraft manufacturing and completion earnings were down in the third quarter and first nine months of 2009 because of lower new aircraft deliveries. The addition of Jet Aviation's completions business partially offset the impact of the Gulfstream production cuts. Despite the volume decline, aircraft manufacturing margins improved in the quarter and year-to-date because of cost-reduction initiatives, a favorable mix of aircraft deliveries and liquidated damages received on defaulted contracts. The group continues to focus on reducing costs through production improvements and operational efficiencies to maintain operating margins in the aircraft manufacturing process.

An increase in the global supply of pre-owned aircraft put significant pressure on the pre-owned aircraft market, resulting in a sharp decline in pre-owned prices in 2009. As a result, the group wrote down the carrying value of its pre-owned aircraft inventory in 2009. The group has worked to minimize its pre-owned aircraft exposure and as a result, has reduced its pre-owned aircraft inventory to four units with a value of $62 at the end of the third quarter from six units at a value of $125 in the second quarter.

Aircraft services earnings, which include Jet Aviation's maintenance and repair activities, fixed-base operations and aircraft management services, decreased slightly in the third quarter and first nine months of 2009 compared with 2008. The group is experiencing competitive pressure on its aircraft services margins because of the market-wide reduction in maintenance and repair volume.

The group's operating earnings in 2009 were also negatively impacted by severance costs associated with workforce reduction activities and intangible asset amortization related to the Jet Aviation acquisition.

As a result of the factors discussed above and the addition of the lower-margin Jet Aviation business, the group's overall operating margins were down 930 basis points in the quarter and 550 basis points in the first nine months of 2009 compared to the same prior-year periods.

We expect Aerospace revenues for 2009, including a full year of Jet Aviation, to be down approximately 4 percent compared with the group's 2008 results because of the impact of the reduced aircraft-production schedule. We expect the group's full-year operating margins to be down from 2008 to a range between 13.2 and 13.4 percent due to the addition of Jet Aviation, losses incurred to date in the pre-owned market and pressures on pricing in the group's services business.

Combat Systems



                                October 4       September 28
          Three Months Ended      2009              2008              Variance
          Revenues             $     2,347      $       1,850      $   497   26.9 %
          Operating earnings           316                262           54   20.6 %
          Operating margin            13.5 %             14.2 %

                                October 4       September 28
          Nine Months Ended       2009              2008              Variance
          Revenues             $     7,159      $       5,862      $ 1,297   22.1 %
          Operating earnings           895                803           92   11.5 %
          Operating margin            12.5 %             13.7 %

The Combat Systems group was our revenue growth leader in the third quarter and first nine months of 2009. The group's organic growth rate was 22 percent in the third quarter and 17 percent in the first nine months of 2009. The increase in the group's revenues consisted of the following:

                                          Third Quarter        Nine Months
            U.S. military vehicles       $           282      $         811
            Weapons systems                          131                341
            Munitions                                 (3 )               54
            European military vehicles                87                 91
            Total increase in revenues   $           497      $       1,297

The U.S. military vehicle business contributed over half the group's revenue growth in the third quarter and first nine months of 2009 due to increased activity on the Stryker wheeled combat vehicle and Abrams main battle tank programs. The Stryker activity related to continued vehicle production, logistics services and engineering efforts for the U.S. Army. The increased Abrams work resulted from the group's progress in upgrading the remaining M1A1 tanks to the M1A2 System Enhancement Package (SEP) configuration, as well as production of Abrams tank kits for Egypt. The acquisition of AxleTech International in the fourth quarter of 2008 also contributed to Combat Systems' revenue growth in 2009. In the group's European military vehicle business, revenues were up as a result of increased activity on several vehicle production programs, including the Piranha wheeled armored vehicle contract for Belgium and the Eagle wheeled armored vehicle program for Germany, as well as higher volume on arms and munitions and mobile bridge programs.

The Combat Systems group's operating earnings increased in the third quarter and first nine months of 2009. While the group's margins have improved sequentially each quarter in 2009, operating margins decreased 70 basis points in the quarter and 120 basis points year-to-date when compared to 2008. The group's margins in 2008 were unusually high because of a favorable program mix, most notably within the mine-resistant, ambush-protected (MRAP) vehicle program. The 2009 sequential margin expansion resulted from productivity improvements in each of the group's businesses.

We expect revenue growth for the full-year 2009 in Combat Systems of approximately 21 percent compared to 2008 with operating margins between 12.5 and 12.7 percent.

Marine Systems



                                 October 4       September 28
           Three Months Ended      2009              2008             Variance
           Revenues             $     1,518      $       1,404      $ 114    8.1 %
           Operating earnings           155                140         15   10.7 %
           Operating margin            10.2 %             10.0 %

                                 October 4       September 28
           Nine Months Ended       2009              2008             Variance
           Revenues             $     4,812      $       4,176      $ 636   15.2 %
           Operating earnings           486                389         97   24.9 %
           Operating margin            10.1 %              9.3 %

The Marine Systems group's revenues and operating earnings increased significantly in the third quarter and first nine months of 2009 over the same prior-year periods. Each of the group's shipyards contributed to this growth. The increase in the group's revenues consisted of the following:

                                                       Third Quarter            Nine Months
Multi-year Navy ship construction                     $            72          $         438
Other Navy ship design, construction,
engineering and repair                                             47                    157
Commercial ship construction                                       (5 )                   41
Total increase in revenues                            $           114          $         636

The group's multi-year ship-construction programs for the U.S. Navy include submarines (Virginia Class), combat-logistics ships (T-AKE) and destroyers (DDG-51 and DDG-1000). Increased activity on the Virginia-class program has been the principal driver of the group's revenue growth to-date in 2009. The group continued building the remaining five submarines under the Block II contract and began construction on the first submarine under the Block III contract, which was awarded in the fourth quarter of 2008. Deliveries on the Block II and III contracts are scheduled through 2019.

Activity on the group's 14-ship T-AKE program was down slightly in the third quarter, consistent with expectations, but remained steady compared with the year-to-date 2008 level as construction continued on the ninth through 12th ships. The group delivered the seventh and eighth T-AKE ships in 2009, the ninth ship is scheduled for delivery in the first quarter of 2010 and deliveries of the remaining ships are scheduled through 2012.

Destroyer construction revenues were up as activity increased on the group's design and production contracts for the DDG-1000 next-generation destroyer, while the workload on the DDG-51 Arleigh Burke program decreased slightly, in line with our expectations. The remaining three DDG-51s under contract are scheduled for delivery through 2011, and the first DDG-1000 delivery is scheduled in 2013.

In addition to these ship-construction programs, volume increased significantly in the third quarter and first nine months of 2009 on engineering and repair programs for the Navy. In commercial shipbuilding, volume was down slightly on the group's five-ship product carrier program in the third quarter but increased year-to-date. The first two ships under contract were delivered in the first nine months of 2009, and construction is in process on the remaining three ships. The third ship is scheduled to be delivered in the fourth quarter of 2009. The current construction plan includes deliveries through the fourth quarter of 2010.

The group generated substantial operating earnings growth in the third quarter and first nine months of 2009 on improved performance at each of the group's shipyards. Based on labor and material cost reductions achieved through ongoing operational efficiency efforts at all three locations, the group has increased earnings rates on several key programs in 2009, including the Virginia-class, DDG-51, DDG-1000 and commercial product carrier programs. As a result, the group's operating margins increased 20 basis points in the third quarter and 80 basis points in the first nine months of 2009 compared with 2008. This performance follows 24 percent earnings growth and 100 basis points of margin improvement in the full-year 2008 over 2007.

We expect Marine Systems to generate revenue growth of approximately 15 percent for the full-year 2009 with operating margins of approximately 10 percent.

Information Systems and Technology



                                 October 4        September 28
           Three Months Ended      2009               2008            Variance
           Revenues             $     2,734      $        2,514      $ 220   8.8 %
           Operating earnings           296                 270         26   9.6 %
           Operating margin            10.8 %              10.7 %

                                 October 4        September 28
           Nine Months Ended       2009               2008            Variance
           Revenues             $     8,122      $        7,430      $ 692   9.3 %
           Operating earnings           869                 822         47   5.7 %
           Operating margin            10.7 %              11.1 %

The Information Systems and Technology group's revenues increased in the third quarter and first nine months of 2009 compared with the same periods in 2008. As a result of this growth, the group reported its highest quarterly revenues and operating earnings to date in the third quarter. The group generated organic revenue growth of 6 percent in the third quarter and 7 percent in the first nine months of 2009 with the remainder of the growth provided by acquisitions in the group's information technology (IT) services and intelligence mission systems businesses. Each of the group's market segments contributed to the increase in revenues in 2009:

                                                   Third Quarter     Nine Months
    Information technology and mission services   $            78   $         277
    Tactical and strategic mission systems                     57             245
    Intelligence mission systems                               85             170
    Total increase in revenues                    $           220   $         692

The largest driver of the revenue growth in the IT services business in 2009 was recent acquisitions. In the third quarter and first nine months of 2009, approximately one-third of the group's IT services revenue growth was organic and resulted from higher volume on several of the group's IT infrastructure programs. These programs included the New Campus East (NCE) contract for the National Geospatial Intelligence Agency and the Warfighter Field Operations Customer Support (FOCUS) contract. A decline in commercial wireless infrastructure activity tempered this business's growth.

In the group's tactical systems business, revenues were up in 2009 as a result of increased activity on several long-term contracts to supply the U.S. military with mobile command-and-control, communications and computing capabilities, including the Warfighter Information Network - Tactical (WIN-T) and Common Hardware/Software III (CHS-3) programs. Higher sales of encryption products also contributed to the revenue growth in 2009.

The intelligence systems business had the group's strongest revenue growth rate in the third quarter and first nine months of 2009. Increased volume across all areas of the intelligence systems business drove this revenue growth in 2009. The most notable drivers were several integrated combat systems contracts, cyber security programs and a contract to build the spacecraft for NASA's Landsat Data Continuity Mission. The acquisition of Axsys Technologies, Inc., in September 2009, also contributed to the group's revenue growth.

Operating earnings in the Information Systems and Technology group increased in the third quarter and first nine months of 2009. A favorable shift in contract mix, particularly within the intelligence systems business, resulted in a 10-basis-point increase in the group's operating margins over the third quarter of 2008. Year-to-date in 2009, the group's contract mix included a higher percentage of lower-margin services contracts. As a result, the group's operating margins for the first nine months of 2009 decreased 40 basis points compared to the same period in 2008.

We expect full-year 2009 revenue growth in the Information Systems and Technology group of approximately 8 to 9 percent. Based on the group's scheduled program mix for 2009, we expect full-year operating margins in the 10.4 to 10.5 percent range.

Corporate

Corporate results consist primarily of compensation expense for stock options and a portion of the results from our commercial pension plans. Corporate operating expenses totaled $18 in the third quarter of 2009 compared with $20 in the third quarter of 2008. The Corporate third quarter 2009 operating results included a $5 gain from the sale of real estate. Year-to-date Corporate operating expenses were $66 in the first nine months of 2009 compared with $56 in the same period in 2008. The year-to-date increase is due primarily to higher stock option expense. We expect 2009 Corporate expense to be approximately $90.

Backlog

The following table details the backlog and the total estimated contract value
of each business group at the end of the third and second quarters of 2009:



                                                                                Estimated        Total
. . .