General Dynamics 2015 Annual Report Download - page 56

In the performance of our contracts, we routinely request contract
modifications that require additional funding from the customer. Most
often, these requests are due to customer-directed changes in the
scope of work. While we are entitled to recovery of these costs under
our contracts, the administrative process with our customer may be
protracted. Based upon the circumstances, we periodically file requests
for equitable adjustment (REAs) that are sometimes converted into
claims. In some cases, these requests are disputed by our customer.
We believe our outstanding modifications, REAs and other claims will
be resolved without material impact to our results of operations,
financial condition or cash flows.
Letters of Credit and Guarantees. In the ordinary course of
business, we have entered into letters of credit, bank guarantees,
surety bonds and other similar arrangements with financial institutions
and insurance carriers totaling approximately $1.1 billion on
December 31, 2015. In addition, from time to time and in the ordinary
course of business, we contractually guarantee the payment or
performance obligations of our subsidiaries arising under certain
contracts.
Aircraft Trade-ins. In connection with orders for new aircraft in
funded contract backlog, our Aerospace group has outstanding options
with some customers to trade in aircraft as partial consideration in their
new-aircraft transaction. These trade-in commitments are structured to
establish the fair market value of the trade-in aircraft at a date
generally 45 or fewer days preceding delivery of the new aircraft to the
customer. At that time, the customer is required to either exercise the
option or allow its expiration. Any excess of the pre-established trade-
in price above the fair market value at the time the new outfitted
aircraft is delivered is treated as a reduction of revenue in the new-
aircraft sales transaction.
Labor Agreements. Approximately one-fifth of the employees of
our subsidiaries work under collectively-bargained terms and
conditions, including 53 collective agreements that we have negotiated
directly with unions and works councils. A number of these agreements
expire within any given year. Historically, we have been successful at
renegotiating these labor agreements without any material disruption of
operating activities. In 2016, we expect to negotiate the terms of 18
agreements covering approximately 6,400 employees. We do not
expect the renegotiations will, either individually or in the aggregate,
have a material impact on our results of operations, financial condition
or cash flows.
Product Warranties. We provide warranties to our customers
associated with certain product sales. We record estimated warranty
costs in the period in which the related products are delivered. The
warranty liability recorded at each balance sheet date is generally
based on the number of months of warranty coverage remaining for
the products delivered and the average historical monthly warranty
payments. Warranty obligations incurred in connection with long-term
production contracts are accounted for within the contract estimates at
completion. Our other warranty obligations, primarily for business-jet
aircraft, are included in other current and noncurrent liabilities on the
Consolidated Balance Sheets.
The changes in the carrying amount of warranty liabilities for each of
the past three years were as follows:
Year Ended December 31 2015 2014 2013
Beginning balance $ 428 $ 354 $ 316
Warranty expense 158 146 125
Payments (120) (78) (82)
Adjustments (1) 6 (5)
Ending balance $ 465 $ 428 $ 354
O. EQUITY COMPENSATION PLANS
Equity Compensation Overview. We have equity compensation plans
for employees, as well as for non-employee members of our board of
directors. The equity compensation plans seek to provide an effective
means of attracting, retaining and motivating directors, officers and key
employees, and to provide them with incentives to enhance our growth
and profitability. Under the equity compensation plans, awards may be
granted to officers, employees or non-employee directors in common
stock, options to purchase common stock, restricted shares of common
stock, participation units or any combination of these.
We grant annual stock option awards to participants in the equity
compensation plans on the first Wednesday of March based on the
average of the high and low stock prices on that day as listed on the New
York Stock Exchange. We may make limited ad hoc grants at other times
during the year for new hires or promotions. Stock options granted under
the equity compensation plans are issued with an exercise price at the
fair market value of the common stock on the date of grant.
In 2015, we made several changes to the equity compensation
program, including an increase in the term of the stock options from
seven to ten years and a change to a three-year vesting period versus a
two-year vesting period for prior option grants. Stock options now vest
over three years, with 50 percent of the options vesting after two years
and the remaining 50 percent vesting the following year.
Outstanding stock options granted prior to 2015 vest over two years,
with 50 percent of the options vesting in one year and the remaining 50
percent vesting the following year, and expire seven years after the grant
date.
Grants of restricted stock are awards of shares of common stock that
vest approximately four years after the grant date. During the restriction
period, recipients may not sell, transfer, pledge, assign or otherwise
52 General Dynamics Annual Report 2015