10-Q 1 lmtq3201710q.htm 10-Q Document

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 
 
FORM 10-Q 
 
 
 
Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended September 24, 2017
Commission file number: 1-11437 
 
LOCKHEED MARTIN CORPORATION
(Exact name of registrant as specified in its charter) 
Maryland
 
52-1893632
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
6801 Rockledge Drive, Bethesda, Maryland
 
20817
(Address of principal executive offices)
 
(Zip Code)
(301) 897-6000
(Registrant’s telephone number, including area code) 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES   NO 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES   NO 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non–accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b–2 of the Exchange Act.
Large accelerated filer Accelerated filer Non–accelerated filer Smaller reporting company Emerging growth company 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES NO
There were 286,734,181 shares of our common stock, $1 par value per share, outstanding as of September 24, 2017.

 
 



Lockheed Martin Corporation
Form 10-Q
For the Quarterly Period Ended September 24, 2017
Table of Contents 
 
 
 
Page
 
 
 
 
 
 
 
 
ITEM 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ITEM 2.
 
 
 
 
 
ITEM 3.
 
 
 
 
 
ITEM 4.
 
 
 
 
 
 
 
 
ITEM 1.
 
 
 
 
 
ITEM 1A.
 
 
 
 
 
ITEM 2.
 
 
 
 
 
ITEM 6.
 
 
 




PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Lockheed Martin Corporation
Consolidated Statements of Earnings
(unaudited; in millions, except per share data)
 
 
Quarters Ended
 
Nine Months Ended
  
 
September 24,
2017
 
September 25,
2016
 
September 24,
2017
 
September 25,
2016
Net sales
 
 
 
 
 
 
 
 
 
 
 
 
Products
 
$
10,496

 
 
$
10,062

 
 
$
30,837

 
 
$
28,629

 
Services
 
1,673

 
 
1,489

 
 
5,074

 
 
4,867

 
Total net sales
 
12,169

 
 
11,551

 
 
35,911

 
 
33,496

 
Cost of sales
 
 
 
 
 
 
 
 
 
 
 
 
Products
 
(9,481
)
 
 
(9,027
)
 
 
(27,919
)
 
 
(25,787
)
 
Services
 
(1,513
)
 
 
(1,313
)
 
 
(4,547
)
 
 
(4,321
)
 
Severance charges
 

 
 

 
 

 
 
(80
)
 
Other unallocated, net
 
176

 
 
173

 
 
484

 
 
401

 
Total cost of sales
 
(10,818
)
 
 
(10,167
)
 
 
(31,982
)
 
 
(29,787
)
 
Gross profit
 
1,351

 
 
1,384

 
 
3,929

 
 
3,709

 
Other income, net
 
77

 
 
204

 
 
133

 
 
412

 
Operating profit
 
1,428

 
 
1,588

 
 
4,062

 
 
4,121

 
Interest expense
 
(162
)
 
 
(162
)
 
 
(477
)
 
 
(492
)
 
Other non-operating (expense) income, net
 
(7
)
 
 
1

 
 
(8
)
 
 
2

 
Earnings from continuing operations before income taxes
 
1,259

 
 
1,427

 
 
3,577

 
 
3,631

 
Income tax expense
 
(320
)
 
 
(338
)
 
 
(933
)
 
 
(837
)
 
Net earnings from continuing operations
 
939

 
 
1,089

 
 
2,644

 
 
2,794

 
Net earnings from discontinued operations
 

 
 
1,306

 
 

 
 
1,520

 
Net earnings
 
$
939

 
 
$
2,395

 
 
$
2,644

 
 
$
4,314

 
Earnings per common share
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
 
 
 
 
 
 
 
 
 
 
 
Continuing operations
 
$
3.27

 
 
$
3.64

 
 
$
9.16

 
 
$
9.25

 
Discontinued operations
 

 
 
4.38

 
 

 
 
5.03

 
Basic earnings per common share
 
$
3.27

 
 
$
8.02

 
 
$
9.16

 
 
$
14.28

 
Diluted
 
 
 
 
 
 
 
 
 
 
 
 
Continuing operations
 
$
3.24

 
 
$
3.61

 
 
$
9.08

 
 
$
9.13

 
Discontinued operations
 

 
 
4.32

 
 

 
 
4.97

 
Diluted earnings per common share
 
$
3.24

 
 
$
7.93

 
 
$
9.08

 
 
$
14.10

 
Cash dividends paid per common share
 
$
1.82

 
 
$
1.65

 
 
$
5.46

 
 
$
4.95

 
The accompanying notes are an integral part of these unaudited consolidated financial statements.


3


Lockheed Martin Corporation
Consolidated Statements of Comprehensive Income
(unaudited; in millions)
 
 
Quarters Ended
 
Nine Months Ended
 
 
September 24,
2017
 
September 25,
2016
 
September 24,
2017
 
September 25,
2016
Net earnings
 
$
939

 
 
$
2,395

 
 
$
2,644

 
 
$
4,314

 
Other comprehensive income, net of tax
 
 
 
 
 
 
 
 
 
 
 
 
Postretirement benefit plans
 
 
 
 
 
 
 
 
 
 
 
 
Amounts reclassified from accumulated other comprehensive loss
 
200

 
 
175

 
 
602

 
 
521

 
Reclassification from divestiture of IS&GS
 

 
 
(134
)
 
 

 
 
(134
)
 
Other comprehensive gain recognized during the period
 

 
 

 
 
3

 
 

 
Other, net
 
77

 
 
72

 
 
137

 
 
66

 
Other comprehensive income, net of tax
 
277

 
 
113

 
 
742

 
 
453

 
Comprehensive income
 
$
1,216

 
 
$
2,508

 
 
$
3,386

 
 
$
4,767

 
The accompanying notes are an integral part of these unaudited consolidated financial statements.


4


Lockheed Martin Corporation
Consolidated Balance Sheets
(in millions, except par value)
 
 
September 24,
2017
 
December 31,
2016
 
 
(unaudited)
 
 
 
Assets
 
 
 
 
 
 
Current assets
 
 
 
 
 
 
Cash and cash equivalents
 
$
2,941

 
 
$
1,837

 
Receivables, net
 
9,021

 
 
8,202

 
Inventories, net
 
4,803

 
 
4,670

 
Other current assets
 
443

 
 
399

 
Total current assets
 
17,208

 
 
15,108

 
Property, plant and equipment, net
 
5,511

 
 
5,549

 
Goodwill
 
10,812

 
 
10,764

 
Intangible assets, net
 
3,877

 
 
4,093

 
Deferred income taxes
 
5,970

 
 
6,625

 
Other noncurrent assets
 
5,568

 
 
5,667

 
Total assets
 
$
48,946

 
 
$
47,806

 
Liabilities and equity
 
 
 
 
 
 
Current liabilities
 
 
 
 
 
 
Accounts payable
 
$
2,848

 
 
$
1,653

 
Customer advances and amounts in excess of costs incurred
 
6,195

 
 
6,776

 
Salaries, benefits and payroll taxes
 
1,895

 
 
1,764

 
Other current liabilities
 
2,146

 
 
2,349

 
Total current liabilities
 
13,084

 
 
12,542

 
Long-term debt, net
 
14,268

 
 
14,282

 
Accrued pension liabilities
 
13,998

 
 
13,855

 
Other postretirement benefit liabilities
 
858

 
 
862

 
Other noncurrent liabilities
 
4,563

 
 
4,659

 
Total liabilities
 
46,771

 
 
46,200

 
Stockholders’ equity
 
 
 
 
 
 
Common stock, $1 par value per share
 
285

 
 
289

 
Additional paid-in capital
 

 
 

 
Retained earnings
 
13,173

 
 
13,324

 
Accumulated other comprehensive loss
 
(11,360
)
 
 
(12,102
)
 
Total stockholders’ equity
 
2,098

 
 
1,511

 
Noncontrolling interests in subsidiary
 
77

 
 
95

 
Total equity
 
2,175

 
 
1,606

 
Total liabilities and equity
 
$
48,946

 
 
$
47,806

 
The accompanying notes are an integral part of these unaudited consolidated financial statements.


5


Lockheed Martin Corporation
Consolidated Statements of Cash Flows
(unaudited; in millions)
 
 
Nine Months Ended
  
 
September 24,
2017
 
September 25,
2016
Operating activities
 
 
 
 
 
 
Net earnings
 
$
2,644

 
 
$
4,314

 
Adjustments to reconcile net earnings to net cash provided by operating activities
 
 
 
 
 
 
Depreciation and amortization
 
880

 
 
888

 
Stock-based compensation
 
133

 
 
124

 
Severance charges
 

 
 
99

 
Gain on divestiture of IS&GS business segment
 

 
 
(1,234
)
 
Gain on step acquisition of AWE
 

 
 
(104
)
 
Changes in assets and liabilities
 
 
 
 
 
 
Receivables, net
 
(819
)
 
 
(1,537
)
 
Inventories, net
 
(133
)
 
 
(235
)
 
Accounts payable
 
1,229

 
 
1,033

 
Customer advances and amounts in excess of costs incurred
 
(581
)
 
 
57

 
Postretirement benefit plans
 
1,012

 
 
787

 
Income taxes
 
(202
)
 
 
37

 
Other, net
 
801

 
 
231

 
Net cash provided by operating activities
 
4,964

 
 
4,460

 
Investing activities
 
 
 
 
 
 
Capital expenditures
 
(670
)
 
 
(627
)
 
Other, net
 
15

 
 
76

 
Net cash used for investing activities
 
(655
)
 
 
(551
)
 
Financing activities
 
 
 
 
 
 
Special cash payment from divestiture of IS&GS business segment
 

 
 
1,800

 
Repurchases of common stock
 
(1,500
)
 
 
(1,280
)
 
Dividends paid
 
(1,591
)
 
 
(1,518
)
 
Repayments of long-term debt
 

 
 
(952
)
 
Proceeds from stock option exercises
 
62

 
 
75

 
Other, net
 
(176
)
 
 
(229
)
 
Net cash used for financing activities
 
(3,205
)
 
 
(2,104
)
 
Net change in cash and cash equivalents
 
1,104

 
 
1,805

 
Cash and cash equivalents at beginning of period
 
1,837

 
 
1,090

 
Cash and cash equivalents at end of period
 
$
2,941

 
 
$
2,895

 
The accompanying notes are an integral part of these unaudited consolidated financial statements.


6


Lockheed Martin Corporation
Consolidated Statements of Equity
(unaudited; in millions)
 
Common
Stock
Additional
Paid-in
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Loss
Total
Stockholders’
Equity
Noncontrolling
Interests in
Subsidiary
Total
Equity
Balance at December 31, 2016
$
289

$

$
13,324

$
(12,102
)
 
$
1,511

 
$
95

 
$
1,606

Net earnings


2,644


 
2,644

 

 
2,644

Other comprehensive income, net of tax



742

 
742

 

 
742

Repurchases of common stock
(5
)
(282
)
(1,213
)

 
(1,500
)
 

 
(1,500
)
Dividends declared


(1,582
)

 
(1,582
)
 

 
(1,582
)
Stock-based awards and ESOP activity
1

282



 
283

 

 
283

Net decrease in noncontrolling interests in subsidiary




 

 
(18
)
 
(18
)
Balance at September 24, 2017
$
285

$

$
13,173

$
(11,360
)
 
$
2,098

 
$
77

 
$
2,175

 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
$
303

$

$
14,238

$
(11,444
)
 
$
3,097

 
$

 
$
3,097

Net earnings


4,314


 
4,314

 

 
4,314

Other comprehensive income, net of tax



453

 
453

 

 
453

Shares tendered and retired in connection with divestiture of IS&GS business segment
(9
)

(2,488
)

 
(2,497
)
 
 
 
(2,497
)
Repurchases of common stock
(6
)
(272
)
(1,002
)

 
(1,280
)
 

 
(1,280
)
Dividends declared


(2,056
)

 
(2,056
)
 

 
(2,056
)
Stock-based awards, ESOP activity and other
3

272

17


 
292

 

 
292

Net increase in noncontrolling interests in subsidiary




 

 
107

 
107

Balance at September 25, 2016
$
291

$

$
13,023

$
(10,991
)
 
$
2,323

 
$
107

 
$
2,430

The accompanying notes are an integral part of these unaudited consolidated financial statements.


7

Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited)



NOTE 1 – BASIS OF PRESENTATION
We prepared these consolidated financial statements in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information, the instructions to Form 10-Q and Article 10 of U.S. Securities and Exchange Commission (SEC) Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. We followed the accounting policies disclosed in the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2016 (2016 Form 10-K) filed with the SEC.
In the opinion of management, these consolidated financial statements reflect all adjustments that are of a normal recurring nature necessary for a fair presentation of our results of operations, financial condition and cash flows for the interim periods presented. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We base these estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Our actual results may differ materially from these estimates. Significant estimates inherent in the preparation of our consolidated financial statements include, but are not limited to, accounting for sales and cost recognition, postretirement benefit plans, environmental receivables and liabilities, evaluation of goodwill and other assets for impairment, income taxes including deferred tax assets, fair value measurements and contingencies. The consolidated financial statements include the accounts of subsidiaries we control and variable interest entities if we are the primary beneficiary. We eliminate intercompany balances and transactions in consolidation.
We close our books and records on the last Sunday of the calendar quarter, which was on September 24 for the third quarter of 2017 and September 25 for the third quarter of 2016, to align our financial closing with our business processes. The consolidated financial statements and tables of financial information included herein are labeled based on that convention. This practice only affects interim periods as our fiscal year ends on December 31.
The discussion and presentation of the operating results of our business segments have been impacted by the following recent events.
On August 16, 2016, we divested our former Information Systems & Global Solutions (IS&GS) business, which merged with Leidos Holdings, Inc. (Leidos) in a Reverse Morris Trust transaction. Accordingly, the operating results of the IS&GS business for the quarter and nine months ended September 25, 2016 have been classified as discontinued operations in the consolidated statements of earnings. However, the cash flows of the IS&GS business for the nine months ended September 25, 2016 have not been reclassified in our consolidated statement of cash flows as we retained the cash as part of the transaction. See “Note 3 – Divestiture” for additional information about the divestiture of the IS&GS business.
On August 24, 2016, we increased our ownership interest in the AWE Management Limited (AWE) joint venture from 33% to 51%, at which time we began consolidating AWE. Consequently, our operating results for the quarter and nine months ended September 24, 2017 include 100% of AWE’s sales and 51% of its operating profit. Prior to increasing our ownership interest, we accounted for our investment in AWE using the equity method of accounting. Under the equity method, we recognized only 33% of AWE’s earnings or losses and no sales. Accordingly, prior to August 24, 2016, the date we obtained control, we recorded 33% of AWE's net earnings in our operating results and subsequent to August 24, 2016, we recognized 100% of AWE's sales and 51% of its operating profit. Additionally, during the quarter and nine months ended September 25, 2016, we recorded a gain of $104 million associated with obtaining control of AWE, which consisted of a $127 million pre-tax gain recognized in the operating results of our Space Systems business segment and $23 million of deferred tax liabilities recorded at our corporate office. 
The results of operations for the interim periods presented are not necessarily indicative of results to be expected for the full year or future periods. Unless otherwise noted, we present all per share amounts cited in these consolidated financial statements on a “per diluted share” basis. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our 2016 Form 10-K.

8


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

NOTE 2 – EARNINGS PER COMMON SHARE
The weighted average number of shares outstanding used to compute earnings per common share were as follows (in millions): 
 
 
Quarters Ended
 
Nine Months Ended
  
 
September 24,
2017
 
September 25,
2016
 
September 24,
2017
 
September 25,
2016
Weighted average common shares outstanding for basic computations
 
287.1

 
 
298.5

 
 
288.5

 
 
302.0

 
Weighted average dilutive effect of equity awards
 
2.9

 
 
3.6

 
 
2.8

 
 
3.9

 
Weighted average common shares outstanding for diluted computations
 
290.0

 
 
302.1

 
 
291.3

 
 
305.9

 
We compute basic and diluted earnings per common share by dividing net earnings by the respective weighted average number of common shares outstanding for the periods presented. Our calculation of diluted earnings per common share also includes the dilutive effects for the assumed vesting of outstanding restricted stock units (RSUs) and performance stock units (PSUs) and exercise of outstanding stock options based on the treasury stock method. There were no significant anti-dilutive equity awards during the quarters and nine months ended September 24, 2017 or September 25, 2016.
NOTE 3 – DIVESTITURE
Divestiture of the Information Systems & Global Solutions Business
On August 16, 2016, we divested our former IS&GS business, which merged with Leidos, in a Reverse Morris Trust transaction (the Transaction). The Transaction was completed in a multi-step process pursuant to which we initially contributed the IS&GS business to Abacus Innovations Corporation (Abacus), a wholly-owned subsidiary of Lockheed Martin created to facilitate the Transaction, and the common stock of Abacus was distributed to participating Lockheed Martin stockholders through an exchange offer. Under the terms of the exchange offer, Lockheed Martin stockholders had the option to exchange shares of Lockheed Martin common stock for shares of Abacus common stock. At the conclusion of the exchange offer, all shares of Abacus common stock were exchanged for 9,369,694 shares of Lockheed Martin common stock held by Lockheed Martin stockholders that elected to participate in the exchange. The shares of Lockheed Martin common stock that were exchanged and accepted were retired, reducing the number of shares of our common stock outstanding by approximately 3%. Following the exchange offer, Abacus merged with a subsidiary of Leidos, with Abacus continuing as the surviving corporation and a wholly-owned subsidiary of Leidos.
As a result of the Transaction, we recognized a net gain of $1.2 billion in net earnings from discontinued operations during the quarter and nine months ended September 25, 2016. The net gain represents the $2.5 billion fair value of the shares of Lockheed Martin common stock exchanged and retired as part of the exchange offer, plus a $1.8 billion one-time special cash payment received from Abacus, less the net book value of the IS&GS business of about $3.0 billion at August 16, 2016 and other adjustments of about $100 million. The final gain is subject to certain post-closing adjustments, including final working capital, indemnification, and tax adjustments.

9


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

The operating results of the IS&GS business that have been reflected within net earnings from discontinued operations for the quarter and nine months ended September 25, 2016 are as follows (in millions): 
 
 
Quarter
Ended
 
Nine Months
Ended
Net sales
 
$
739

 
 
$
3,410

 
Cost of sales
 
(635
)
 
 
(2,953
)
 
Severance charges
 

 
 
(19
)
 
Gross profit
 
104

 
 
438

 
Other income, net
 
19

 
 
16

 
Operating profit
 
123

 
 
454

 
Earnings from discontinued operations before income taxes
 
123

 
 
454

 
Income tax expense
 
(51
)
 
 
(168
)
 
Net gain on divestiture of discontinued operations
 
1,234

 
 
1,234

 
Net earnings from discontinued operations
 
$
1,306

 
 
$
1,520

 
The operating results of the IS&GS business reported as discontinued operations for the quarter and nine months ended September 25, 2016 are different than the results previously reported for our former IS&GS business segment. Certain corporate overhead and pension costs that were historically allocated to and included in the operating results of IS&GS during the quarter and nine months ended September 25, 2016 have been reclassified into unallocated items and included in the results of our continuing operations because they were not directly attributable to IS&GS and we continue to incur these costs subsequent to the divestiture.
The amount of corporate overhead costs previously included in the operating results of IS&GS that have been reclassified to and included in our earnings from continuing operations were $17 million and $82 million during the quarter and nine months ended September 25, 2016. These costs are included in the other unallocated, net line. Additionally, we retained all assets and obligations related to the pension benefits earned by former IS&GS salaried employees through the date of the divestiture. We continue to incur the non-service portion of net pension costs (e.g., interest cost, actuarial gains and losses and expected return on plan assets) for these employees subsequent to the divestiture. The amount of the non-service pension costs previously included in the operating results of IS&GS that have been reclassified to and included in our continuing operations were $11 million and $54 million during the quarter and nine months ended September 25, 2016. These costs are included in the other unallocated, net line.
Financial information related to cash flows generated by the IS&GS business, such as depreciation and amortization, capital expenditures, and other non-cash items included in our consolidated statement of cash flows for the nine months ended September 25, 2016 were not significant.
In connection with the Transaction, Lockheed Martin retained certain liabilities, including liabilities associated with the New York Metropolitan Transportation Authority and its Capital Construction Company (collectively, the MTA) litigation discussed in “Note 7 – Legal Proceedings and Contingencies,” and has indemnified Abacus and Leidos in connection with other liabilities associated with the IS&GS business, including certain liabilities associated with ongoing investigations by the Department of Energy and the Department of Justice (DOJ) relating to the IS&GS business's involvement in the Mission Support Alliance, LLC (MSA) joint venture that manages and operates the Hanford Nuclear site for the Department of Energy. The DOJ has issued a number of Civil Investigative Demands to MSA, Lockheed Martin and the subsidiary of Lockheed Martin that performed information technology services for MSA, as well as current and former employees of each of these entities, and is continuing its False Claims Act investigation into matters involving MSA and the IS&GS business. The DOJ also is conducting a parallel criminal investigation. The investigations relate primarily to certain information technology services performed by a subsidiary of Lockheed Martin under a fixed price/fixed unit rate subcontract to MSA. In the event that the DOJ were to pursue a claim in connection with the ongoing MSA investigation, through the indemnification provisions agreed to as part of the Transaction, Lockheed Martin and Leidos have allocated liabilities between themselves.

10


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

NOTE 4 – INFORMATION ON BUSINESS SEGMENTS
We operate in four business segments: Aeronautics, Missiles and Fire Control (MFC), Rotary and Mission Systems (RMS) and Space Systems. We organize our business segments based on the nature of the products and services offered.
The financial information in the following tables excludes businesses included in discontinued operations for all periods presented and includes the results of businesses we have acquired from their respective acquisition dates (see “Note 1 – Basis of Presentation”).
Net sales of our business segments exclude intersegment sales as these activities are eliminated in consolidation. Under the equity method of accounting for nonconsolidated ventures and investments, we include our share of the operating profit related to these ventures in operating profit of our business segments as the operating activities of equity method investees are closely aligned with the operations of our business segments. United Launch Alliance (ULA), results of which are included in our Space Systems business segment, is our primary equity method investee. Operating profit of our business segments excludes the FAS/CAS pension adjustment described below; expense for stock-based compensation; the effects of items not considered part of management’s evaluation of segment operating performance, such as charges related to significant severance actions and certain asset impairments; gains or losses from significant divestitures; the effects of certain legal settlements; corporate costs not allocated to our business segments; and other miscellaneous corporate activities. These items are included in the reconciling item “Unallocated items” between operating profit from our business segments and our consolidated operating profit. See “Note 10 – Other(under the caption “Changes in Estimates”) for a discussion related to certain factors that may impact the comparability of net sales and operating profit of our business segments.
Our business segments’ results of operations include pension expense only as calculated under U.S. Government Cost Accounting Standards (CAS), which we refer to as CAS pension cost. We recover CAS pension cost through the pricing of our products and services on U.S. Government contracts and, therefore, the CAS pension cost is recognized in each of our business segments’ net sales and cost of sales. Since our consolidated financial statements must present pension expense calculated in accordance with the financial accounting standards (FAS) requirements under GAAP, which we refer to as FAS pension expense, the FAS/CAS pension adjustment increases or decreases the CAS pension cost recorded in our business segments’ results of operations to equal the FAS pension expense.


11


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

Summary operating results for each of our business segments were as follows (in millions): 
 
 
Quarters Ended
 
Nine Months Ended
  
 
September 24,
2017
 
September 25,
2016
 
September 24,
2017
 
September 25,
2016
Net sales
 
 
 
 
 
 
 
 
 
Aeronautics
 
$
4,771

 
 
$
4,188

 
 
$
14,102

 
 
$
12,362

 
Missiles and Fire Control
 
1,793

 
 
1,737

 
 
4,919

 
 
4,851

 
Rotary and Mission Systems
 
3,353

 
 
3,346

 
 
9,864

 
 
9,653

 
Space Systems
 
2,252

 
 
2,280

 
 
7,026

 
 
6,630

 
Total net sales
 
$
12,169

 
 
$
11,551

 
 
$
35,911

 
 
$
33,496

 
Operating profit
 
 
 
 
 
 
 
 
 
Aeronautics
 
$
517

 
 
$
437

 
 
$
1,503

 
 
$
1,335

 
Missiles and Fire Control
 
270

 
 
289

 
 
757

 
 
763

 
Rotary and Mission Systems
 
244

 
 
247

 
 
606

 
 
678

 
Space Systems (a)
 
218

 
 
450

 
 
762

 
 
1,034

 
Total business segment operating profit
 
1,249

 
 
1,423

 
 
3,628

 
 
3,810

 
Unallocated items
 
 
 
 
 
 
 
 
 
FAS/CAS pension adjustment
 
 
 
 
 
 
 
 
 
FAS pension expense
 
(342
)
 
 
(256
)
 
 
(1,030
)
 
 
(758
)
 
Less: CAS pension cost
 
562

 
 
482

 
 
1,686

 
 
1,430

 
FAS/CAS pension adjustment
 
220

 
 
226

 
 
656

 
 
672

 
Stock-based compensation
 
(32
)
 
 
(28
)
 
 
(133
)
 
 
(124
)
 
Severance charges
 

 
 

 
 

 
 
(80
)
 
Other, net (b) (c)
 
(9
)
 
 
(33
)
 
 
(89
)
 
 
(157
)
 
Total unallocated items
 
179

 
 
165

 
 
434

 
 
311

 
Total consolidated operating profit
 
$
1,428

 
 
$
1,588

 
 
$
4,062

 
 
$
4,121

 
Intersegment sales
 
 
 
 
 
 
 
 
 
Aeronautics
 
$
33

 
 
$
30

 
 
$
98

 
 
$
105

 
Missiles and Fire Control
 
104

 
 
81

 
 
253

 
 
225

 
Rotary and Mission Systems
 
452

 
 
469

 
 
1,438

 
 
1,382

 
Space Systems
 
31

 
 
21

 
 
76

 
 
90

 
Total intersegment sales
 
$
620

 
 
$
601

 
 
$
1,865

 
 
$
1,802

 
 
(a) 
On August 24, 2016, our ownership interest in the AWE joint venture increased from 33% to 51% and we were required to change our accounting for this investment from the equity method to consolidation. As a result of the increased ownership interest, we recognized a non-cash gain of $127 million at our Space Systems business segment, which increased net earnings from continuing operations by $104 million ($0.34 per share) in the quarter and nine months ended September 25, 2016. See “Note 1 – Basis of Presentation” for more information.
(b) 
During the nine months ended September 24, 2017, we recognized a $64 million charge, which represents our portion of a noncash asset impairment charge recorded by our equity method investee, Advanced Military Maintenance, Repair and Overhaul Center LLC (AMMROC). See “Note 10 – Other” (under the caption “Equity Method Investee Impairment”) for more information.
(c) 
Includes $17 million and $82 million of corporate overhead costs incurred during the quarter and nine months ended September 25, 2016 that were previously allocated to our former IS&GS business. See “Note 3 – Divestiture” for more information.



12


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

Total assets for each of our business segments were as follows (in millions):
  
 
September 24,
2017
 
December 31,
2016
Assets
 
 
 
 
 
 
Aeronautics
 
$
7,918

 
 
$
7,896

 
Missiles and Fire Control
 
4,510

 
 
4,000

 
Rotary and Mission Systems
 
18,500

 
 
18,367

 
Space Systems
 
5,425

 
 
5,250

 
Total business segment assets
 
36,353

 
 
35,513

 
Corporate assets (a)
 
12,593

 
 
12,293

 
Total assets
 
$
48,946

 
 
$
47,806

 
(a) 
Corporate assets primarily include cash and cash equivalents, deferred income taxes, environmental receivables, and investments held in a separate trust to fund certain of our non-qualified deferred compensation plans.
Our Aeronautics business segment includes our largest program, the F-35 Lightning II Joint Strike Fighter, an international multi-role, multi-variant, stealth fighter aircraft. Net sales for the F-35 program represented approximately 26% and 25% of our total consolidated net sales for the quarter and nine months ended September 24, 2017 and 23% of our total consolidated net sales for both the quarter and nine months ended September 25, 2016.
NOTE 5 – INVENTORIES, NET
Inventories, net consisted of the following (in millions):
  
 
September 24,
2017
 
December 31,
2016
Work-in-process, primarily related to long-term contracts and programs in progress
 
$
7,720

 
 
$
7,864

 
Spare parts, used aircraft and general stock materials
 
798

 
 
833

 
Other inventories
 
767

 
 
719

 
Total inventories
 
9,285

 
 
9,416

 
Less: customer advances and progress payments
 
(4,482
)
 
 
(4,746
)
 
Total inventories, net
 
$
4,803

 
 
$
4,670

 

13


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

NOTE 6 – POSTRETIREMENT PLANS
Our pretax net periodic benefit cost related to our qualified defined benefit pension plans and retiree medical and life insurance plans consisted of the following (in millions):
 
 
Quarters Ended
 
Nine Months Ended
 
 
September 24,
2017
 
September 25,
2016
 
September 24,
2017
 
September 25,
2016
Qualified defined benefit pension plans
 
 
 
 
 
 
 
 
 
 
 
 
Service cost
 
$
205

 
 
$
208

 
 
$
615

 
 
$
615

 
Interest cost
 
452

 
 
465

 
 
1,357

 
 
1,396

 
Expected return on plan assets
 
(602
)
 
 
(667
)
 
 
(1,806
)
 
 
(2,000
)
 
Recognized net actuarial losses
 
376

 
 
340

 
 
1,129

 
 
1,019

 
Amortization of prior service credits
 
(89
)
 
 
(90
)
 
 
(265
)
 
 
(272
)
 
Total net periodic benefit cost
 
$
342

 
 
$
256

 
 
$
1,030

 
 
$
758

 
Retiree medical and life insurance plans
 
 
 
 
 
 
 
 
 
 
Service cost
 
$
5

 
 
$
6

 
 
$
15

 
 
$
18

 
Interest cost
 
25

 
 
30

 
 
76

 
 
89

 
Expected return on plan assets
 
(31
)
 
 
(34
)
 
 
(95
)
 
 
(103
)
 
Recognized net actuarial losses
 
4

 
 
8

 
 
14

 
 
25

 
Amortization of prior service costs
 
4

 
 
5

 
 
11

 
 
16

 
Total net periodic benefit cost
 
$
7

 
 
$
15

 
 
$
21

 
 
$
45

 
 The recognized net actuarial losses and amortization of net prior service (credits) costs in the table above, along with similar amounts related to our other postretirement benefit plans and 2016 IS&GS reclassifications to discontinued operations ($14 million and $41 million during the quarter and nine months ended September 24, 2017 and $8 million and $18 million for the quarter and nine months ended September 25, 2016), were reclassified from accumulated other comprehensive loss (AOCL) and recorded as a component of net periodic benefit cost for the periods presented. These costs totaled $309 million ($200 million, net of tax) and $930 million ($602 million, net of tax) during the quarter and nine months ended September 24, 2017 and $271 million ($175 million, net of tax) and $806 million ($521 million, net of tax) during the quarter and nine months ended September 25, 2016, which were recorded on our consolidated statements of comprehensive income as an increase to other comprehensive income.
The funding of our qualified defined benefit pension plans is determined in accordance with the Employee Retirement Income Security Act of 1974 (ERISA), as amended by the Pension Protection Act of 2006 (PPA), and in a manner consistent with CAS and Internal Revenue Code rules. There were no material contributions to our qualified defined benefit pension plans during the quarters and nine months ended September 24, 2017 and September 25, 2016. Currently, we do not plan to make material contributions to our pension plans in 2017, because none are required using current assumptions, including anticipated investment returns on plan assets.
NOTE 7 – LEGAL PROCEEDINGS AND CONTINGENCIES
We are a party to or have property subject to litigation and other proceedings that arise in the ordinary course of our business, including matters arising under provisions relating to protection of the environment and are subject to contingencies related to certain businesses we previously owned. These types of matters could result in fines, penalties, compensatory or treble damages or non-monetary sanctions or relief. We believe the probability is remote that the outcome of each of these matters, including the legal proceedings described below, will have a material adverse effect on the corporation as a whole, notwithstanding that the unfavorable resolution of any matter may have a material effect on our net earnings in any particular interim reporting period. Among the factors that we consider in this assessment are the nature of existing legal proceedings and claims, the asserted or possible damages or loss contingency (if estimable), the progress of the case, existing law and precedent, the opinions or views of legal counsel and other advisers, our experience in similar cases and the experience of other companies, the facts available to us at the time of assessment and how we intend to respond to the proceeding or claim. Our assessment of these factors may change over time as individual proceedings or claims progress.

14


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

Although we cannot predict the outcome of legal or other proceedings with certainty, where there is at least a reasonable possibility that a loss may have been incurred, GAAP requires us to disclose an estimate of the reasonably possible loss or range of loss or make a statement that such an estimate cannot be made. We follow a thorough process in which we seek to estimate the reasonably possible loss or range of loss, and only if we are unable to make such an estimate do we conclude and disclose that an estimate cannot be made. Accordingly, unless otherwise indicated below in our discussion of legal proceedings, a reasonably possible loss or range of loss associated with any individual legal proceeding cannot be estimated.
Legal Proceedings
As a result of our acquisition of Sikorsky Aircraft Corporation (Sikorsky), we assumed the defense of and any potential liability for the following civil False Claims Act lawsuit. In October 2014, the U.S. Government filed a complaint in intervention in the U.S. District Court for the Eastern District of Wisconsin in a lawsuit brought by qui tam relator Mary Patzer, a former Derco Aerospace (Derco) employee. The Government alleged that Sikorsky and two of its wholly-owned subsidiaries, Derco and Sikorsky Support Services, Inc. (SSSI), violated the civil False Claims Act in connection with a contract that the U.S. Navy awarded to SSSI in June 2006 to support the Navy’s T-34 and T-44 fixed-wing turboprop training aircraft. SSSI subcontracted with Derco primarily to procure and manage the spare parts for the training aircraft. The Government alleges that SSSI overbilled the Navy on the contract because Derco used prohibited cost-plus-percentage-of-cost pricing to add profit and overhead costs as a percentage of the price of the spare parts that Derco procured and then sold to SSSI. The Government also claims that SSSI submitted false Certificates of Final Indirect Costs in the years 2006 through 2012. The Government’s complaint asserts numerous claims for violations of the False Claims Act, breach of contract and unjust enrichment.
On March 16, 2017, the U.S. Government filed a notice of partial intervention in a lawsuit also pending in the U.S. District Court for the Eastern District of Wisconsin brought by qui tam relator Peter Cimma, a former SSSI employee, against Sikorsky, SSSI and Derco. On May 26, 2017, the Government filed its complaint in intervention, alleging claims against SSSI and Derco under the False Claims Act, Anti-Kickback Act, Truth-in-Negotiations Act, and common law. The Government declined to intervene in Cimma’s allegations against Sikorsky. The Government’s claims against SSSI and Derco rely on many of the same facts and legal elements as in its Patzer complaint, but for a later contract and time period, and add purported violations of the Anti-Kickback Act based on Derco’s allowing SSSI to take a chargeback against Derco’s monthly invoice in exchange for the “highly favorable” pricing arrangement. The Government has indicated that it intends to amend its complaint in Patzer to add claims under the False Claims Act and Anti-Kickback Act related to the chargeback.
The Government currently seeks damages in these lawsuits of approximately $52 million, subject to trebling, plus statutory penalties. We believe that we have legal and factual defenses to the Government’s claims. Although we continue to evaluate our liability and exposure, we do not currently believe that it is probable that we will incur a material loss. If, contrary to our expectations, the Government prevails in this matter and proves damages at or near $52 million and is successful in having such damages trebled, the outcome could have an adverse effect on our results of operations in the period in which a liability is recognized and on our cash flows for the period in which any damages are paid.
On April 24, 2009, we filed a declaratory judgment action against the MTA asking the U.S. District Court for the Southern District of New York to find that the MTA is in material breach of our agreement based on the MTA’s failure to provide access to sites where work must be performed and the customer-furnished equipment necessary to complete the contract. The MTA filed an answer and counterclaim alleging that we breached the contract and subsequently terminated the contract for alleged default. The primary damages sought by the MTA are the cost to complete the contract and potential re-procurement costs. While we are unable to estimate the cost of another contractor to complete the contract and the costs of re-procurement, we note that our contract with the MTA had a total value of $323 million, of which $241 million was paid to us, and that the MTA is seeking damages of approximately $190 million. We dispute the MTA’s allegations and are defending against them. Additionally, following an investigation, our sureties on a performance bond related to this matter, who were represented by independent counsel, concluded that the MTA’s termination of the contract was improper. Finally, our declaratory judgment action was later amended to include claims for monetary damages against the MTA of approximately $95 million. This matter was taken under submission by the District Court in December 2014, after a five-week bench trial and the filing of post-trial pleadings by the parties. We continue to await a decision from the District Court. Although this matter relates to our former IS&GS business, we retained the litigation when we divested IS&GS.

15


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

Environmental Matters
We are involved in proceedings and potential proceedings relating to soil, sediment, surface water and groundwater contamination, disposal of hazardous waste and other environmental matters at several of our current or former facilities and at third-party sites where we have been designated as a potentially responsible party (PRP). A substantial portion of environmental costs will be included in our net sales and cost of sales in future periods pursuant to U.S. Government regulations. At the time a liability is recorded for future environmental costs, we record a receivable for estimated future recovery considered probable through the pricing of products and services to agencies of the U.S. Government, regardless of the contract form (e.g., cost-reimbursable, fixed-price). We continually evaluate the recoverability of our environmental receivables by assessing, among other factors, U.S. Government regulations, our U.S. Government business base and contract mix, our history of receiving reimbursement of such costs, and efforts by some U.S. Government representatives to limit such reimbursement. We include the portion of those environmental costs expected to be allocated to our non-U.S. Government contracts, or that is determined to not be recoverable under U.S. Government contracts, in our cost of sales at the time the liability is established.
At September 24, 2017 and December 31, 2016, the aggregate amount of liabilities recorded relative to environmental matters was $952 million and $1.0 billion, most of which are recorded in other noncurrent liabilities on our consolidated balance sheets. We have recorded receivables totaling $825 million and $870 million at September 24, 2017 and December 31, 2016, most of which are recorded in other noncurrent assets on our consolidated balance sheets, for the estimated future recovery of these costs, as we consider the recovery probable based on the factors previously mentioned. We project costs and recovery of costs over approximately 20 years.
Environmental remediation activities usually span many years, which makes estimating liabilities a matter of judgment because of uncertainties with respect to assessing the extent of the contamination as well as such factors as changing remediation technologies and changing regulatory environmental standards. There are a number of former and present operating facilities that we are monitoring or investigating for potential future remediation. We perform quarterly reviews of the status of our environmental remediation sites and the related liabilities and receivables. Additionally, in our quarterly reviews, we consider these and other factors in estimating the timing and amount of any future costs that may be required for remediation activities and record a liability when it is probable that a loss has occurred and the loss can be reasonably estimated. The amount of liability recorded is based on our estimate of the costs to be incurred for remediation at a particular site. We do not discount the recorded liabilities, as the amount and timing of future cash payments are not fixed or cannot be reliably determined. We reasonably cannot determine the extent of our financial exposure in all cases as, although a loss may be probable or reasonably possible, in some cases it is not possible at this time to estimate the loss or reasonably possible loss or range of loss.
We also pursue claims for recovery of costs incurred or contribution to site cleanup costs against other PRPs, including the U.S. Government, and are conducting remediation activities under various consent decrees, orders, and agreements relating to soil, groundwater, sediment or surface water contamination at certain sites of former or current operations. Under agreements related to certain sites in California and New York, the U.S. Government reimburses us an amount equal to a percentage, specific to each site, of expenditures for certain remediation activities in the U.S. Government’s capacity as a PRP under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA).
In addition to the proceedings and potential proceedings discussed above, California previously established a maximum level of the contaminant hexavalent chromium in drinking water of 10 parts per billion (ppb). Recently, this standard was successfully challenged by the California Manufacturers and Technology Association (CMTA) for failure to conduct the required economic feasibility analysis. In response to the court's ruling, the State Water Resources Control Board (State Board) withdrew the hexavalent chromium standard from the published regulations, leaving only the 50 ppb standard for total chromium. The State Board has indicated it will work to re-establish a hexavalent chromium standard. If the standard for hexavalent chromium is re-established at 10 ppb or above, it will not have a material impact on our existing remediation costs in California. Further, the U.S. Environmental Protection Agency (U.S. EPA) is considering whether to regulate hexavalent chromium.

16


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

California is also reevaluating its existing drinking water standard of 6 ppb for perchlorate, and the U.S. EPA is taking steps to regulate perchlorate in drinking water. If substantially lower standards are adopted, in either California or at the federal level for perchlorate or for hexavalent chromium, we expect a material increase in our estimates for environmental liabilities and the related assets for the portion of the increased costs that are probable of future recovery in the pricing of our products and services for the U.S. Government. The amount that would be allocable to our non-U.S. Government contracts or that is determined to not be recoverable under U.S. Government contracts would be expensed, which may have a material effect on our earnings in any particular interim reporting period.
Letters of Credit, Surety Bonds and Third-Party Guarantees
We have entered into standby letters of credit and surety bonds issued on our behalf by financial institutions, and directly issued guarantees to third parties primarily relating to advances received from customers and the guarantee of future performance on certain contracts. Letters of credit and surety bonds generally are available for draw down in the event we do not perform. In some cases, we may guarantee the contractual performance of third parties such as venture partners. We had total outstanding letters of credit, surety bonds and third-party guarantees aggregating $3.3 billion and $3.7 billion at September 24, 2017 and December 31, 2016. Third-party guarantees do not include guarantees of subsidiaries and other consolidated entities.
At September 24, 2017 and December 31, 2016, third-party guarantees totaled $726 million and $709 million, of which approximately 60% and 56% related to guarantees of contractual performance of ventures to which we currently are or previously were a party. This amount represents our estimate of the maximum amount we would expect to incur upon the contractual non-performance of the venture partners. In addition, we generally have cross-indemnities in place that may enable us to recover amounts that may be paid on behalf of a venture partner. In determining our exposures, we evaluate the reputation, technical capabilities and credit quality of our current and former venture partners. There were no material amounts recorded in our consolidated financial statements related to third-party guarantees.
United Launch Alliance
In connection with our 50% ownership interest of ULA, we and The Boeing Company (Boeing) are required to provide ULA an additional capital contribution if ULA is unable to make required payments under its inventory supply agreement with Boeing. As of September 24, 2017, ULA’s total remaining obligation to Boeing under the inventory supply agreement was $120 million. The parties have agreed to defer the remaining payment obligation, as it is more than offset by other commitments to ULA. Accordingly, we do not expect to be required to make a capital contribution to ULA under this agreement.
In addition, both we and Boeing have cross-indemnified each other for guarantees by us and Boeing of the performance and financial obligations of ULA under certain launch service contracts. We believe ULA will be able to fully perform its obligations, as it has done through September 24, 2017, and that it will not be necessary to make payments under the cross-indemnities or guarantees.

17


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

NOTE 8 – FAIR VALUE MEASUREMENTS
Assets and liabilities measured and recorded at fair value on a recurring basis consisted of the following (in millions):
 
 
September 24, 2017
 
December 31, 2016
  
 
Total
 
Level 1
 
Level 2
 
Total
 
Level 1
 
Level 2
Assets
 
 
 
 
 
 
 
 
Equity securities
 
$
47

 
$
47

 
$

 
$
79

 
$
79

 
$

Mutual funds
 
858

 
858

 

 
856

 
856

 

U.S. Government securities
 
110

 

 
110

 
113

 

 
113

Other securities
 
176

 

 
176

 
151

 

 
151

Derivatives
 
28

 

 
28

 
27

 

 
27

Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives
 
105

 

 
105

 
85

 

 
85

Assets measured at NAV
 
 
 
 
 
 
 
 
 
 
 
 
Other commingled funds
 
18

 
 
 
 
 

 
 
 
 
Substantially all assets measured at fair value, other than derivatives, represent investments classified as trading securities held in a separate trust to fund certain of our non-qualified deferred compensation plans and are recorded in other noncurrent assets on our consolidated balance sheets. The fair values of equity securities and mutual funds are determined by reference to the quoted market price per unit in active markets multiplied by the number of units held without consideration of transaction costs. The fair values of U.S. Government and other securities are determined using pricing models that use observable inputs (e.g., interest rates and yield curves observable at commonly quoted intervals), bids provided by brokers or dealers or quoted prices of securities with similar characteristics. The fair values of derivative instruments, which consist of foreign currency exchange forward and interest rate swap contracts, primarily are determined based on the present value of future cash flows using model-derived valuations that use observable inputs such as interest rates, credit spreads and foreign currency exchange rates. We did not have any transfers of assets or liabilities between levels of the fair value hierarchy during the nine months ended September 24, 2017.
We use derivative instruments principally to reduce our exposure to market risks from changes in foreign currency exchange rates and interest rates. We do not enter into or hold derivative instruments for speculative trading purposes. We transact business globally and are subject to risks associated with changing foreign currency exchange rates. We enter into foreign currency hedges such as forward and option contracts that change in value as foreign currency exchange rates change. These contracts hedge forecasted foreign currency transactions in order to mitigate fluctuations in our earnings and cash flows associated with changes in foreign currency exchange rates. We designate foreign currency hedges as cash flow hedges. We also are exposed to the impact of interest rate changes primarily through our borrowing activities. For fixed rate borrowings, we may use variable interest rate swaps, effectively converting fixed rate borrowings to variable rate borrowings in order to reduce the amount of interest paid. These swaps are designated as fair value hedges. For variable rate borrowings, we may use fixed interest rate swaps, effectively converting variable rate borrowings to fixed rate borrowings in order to mitigate the impact of interest rate changes on earnings. These swaps are designated as cash flow hedges. We also may enter into derivative instruments that are not designated as hedges and do not qualify for hedge accounting, which are intended to mitigate certain economic exposures.
The aggregate notional amount of our outstanding interest rate swaps at both September 24, 2017 and December 31, 2016 was $1.2 billion and the fair value was not significant. The aggregate notional amount of our outstanding foreign currency hedges at September 24, 2017 and December 31, 2016 was $4.4 billion and $4.0 billion and the fair value was not significant. Derivative instruments did not have a material impact on net earnings and comprehensive income during the quarters and nine months ended September 24, 2017 and September 25, 2016. Substantially all of our derivatives are designated for hedge accounting.

18


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

In addition to the financial instruments listed in the table above, we hold other financial instruments, including cash and cash equivalents, receivables, accounts payable and debt. The carrying amounts for cash and cash equivalents, receivables and accounts payable approximated their fair values. The estimated fair value of our outstanding debt was $16.6 billion and $16.2 billion at September 24, 2017 and December 31, 2016. The outstanding principal amount was $15.5 billion and $15.3 billion, excluding unamortized discounts and issuance costs of $1.2 billion and $1.0 billion at September 24, 2017 and December 31, 2016. The estimated fair values of our outstanding debt were determined based on quoted prices for similar instruments in active markets (Level 2).
NOTE 9 – STOCKHOLDERS’ EQUITY
Repurchases of Common Stock
During the nine months ended September 24, 2017, we repurchased 5.4 million shares of our common stock for $1.5 billion. The total remaining authorization for future common share repurchases under our share repurchase program was $2.0 billion as of September 24, 2017. On September 28, 2017, subsequent to the end of our third quarter, our Board of Directors authorized a $2.0 billion increase to the program. As we repurchase our common shares, we reduce common stock for the $1 of par value of the shares repurchased, with the excess purchase price over par value recorded as a reduction of additional paid-in capital. If additional paid-in capital is reduced to zero, we record the remainder of the excess purchase price over par value as a reduction of retained earnings. Due to the volume of repurchases made under our share repurchase program, additional paid-in capital was reduced to zero, with the remainder of the excess purchase price over par value of $1.2 billion and $1.0 billion recorded as a reduction of retained earnings during the nine months ended September 24, 2017 and September 25, 2016, respectively.
Dividends
We declared cash dividends totaling $1.6 billion ($5.46 per share) and $2.1 billion ($6.77 per share) during the nine months ended September 24, 2017 and September 25, 2016. Dividends declared in 2016 includes our fourth quarter dividend of $537 million ($1.82 per share), which was declared during the quarter ended September 25, 2016 and paid in the fourth quarter of 2016. On September 28, 2017, subsequent to the end of our third quarter, we increased our quarterly dividend rate by 10%, or $0.18 per share, to $2.00 per share, and we declared our fourth quarter dividend.
Restricted Stock Unit Grants
During the quarter ended September 24, 2017, there were no significant grants of RSUs. During the nine months ended September 24, 2017, we granted certain employees approximately 0.5 million RSUs with a grant date fair value of $254.53 per RSU. The grant date fair value of these RSUs is equal to the closing market price of our common stock on the grant date less a discount to reflect the delay in payment of dividend-equivalent cash payments that are made only upon vesting, which is generally three years from the grant date. We recognize the grant date fair value of RSUs, less estimated forfeitures, as compensation expense ratably over the requisite service period, which is shorter than the vesting period if the employee is retirement eligible on the date of grant or will become retirement eligible before the end of the vesting period.

19


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

 Accumulated Other Comprehensive Loss
Changes in the balance of AOCL, net of tax, consisted of the following (in millions):
 
 
Postretirement
Benefit Plans
 
Other, net
 
AOCL
Balance at December 31, 2016
 
$
(11,981
)
 
$
(121
)
 
$
(12,102
)
Other comprehensive income before reclassifications
 
3

 
123

 
126

Amounts reclassified from AOCL
 
 
 
 
 
 
Recognition of net actuarial losses (a)
 
774

 

 
774

Amortization of net prior service credits (a)
 
(172
)
 

 
(172
)
Other
 

 
14

 
14

Total reclassified from AOCL
 
602

 
14

 
616

Total other comprehensive income
 
605

 
137

 
742

Balance at September 24, 2017
 
$
(11,376
)
 
$
16

 
$
(11,360
)
 
 
 
 
 
 
 
Balance at December 31, 2015
 
$
(11,314
)
 
$
(130
)
 
$
(11,444
)
Other comprehensive loss before reclassifications
 

 
(46
)
 
(46
)
Amounts reclassified from AOCL
 
 
 
 
 
 
Recognition of net actuarial losses (a)
 
703

 

 
703

Amortization of net prior service credits (a)
 
(182
)
 

 
(182
)
Recognition of net prior service credits from divestiture of IS&GS (b)
 
(134
)
 

 
(134
)
Other
 

 
112

 
112

Total reclassified from AOCL
 
387

 
112

 
499

Total other comprehensive income
 
387

 
66

 
453

Balance at September 25, 2016
 
$
(10,927
)
 
$
(64
)
 
$
(10,991
)
(a) 
Reclassifications from AOCL related to our postretirement benefit plans were recorded as a component of net periodic benefit cost for each period presented (see “Note 6 – Postretirement Plans”). These amounts include $200 million and $175 million, net of tax, for the quarters ended September 24, 2017 and September 25, 2016, which are comprised of the recognition of net actuarial losses of $258 million and $234 million for the quarters ended September 24, 2017 and September 25, 2016 and the amortization of net prior service credits of $(58) million and $(59) million for the quarters ended September 24, 2017 and September 25, 2016.
(b) 
Associated with the divestiture of the IS&GS business and included in net gain on divestiture of discontinued operations.
NOTE 10 – OTHER
Changes in Estimates
Accounting for contracts using the percentage-of-completion method requires judgment relative to assessing risks, estimating contract sales and costs (including estimating award and incentive fees and penalties related to performance) and making assumptions for schedule and technical issues. Due to the number of years it may take to complete many of our contracts and the scope and nature of the work required to be performed on those contracts, the estimation of total sales and costs at completion is complicated and subject to many variables and, accordingly, is subject to change. When adjustments in estimated total contract sales or estimated total costs are required, any changes from prior estimates are recognized in the current period for the inception-to-date effect of such changes. When estimates of total costs to be incurred on a contract exceed estimates of total sales to be earned, a provision for the entire loss on the contract is recorded in the period in which the loss is determined.

20


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

Many of our contracts span several years and include highly complex technical requirements. At the outset of a contract, we identify and monitor risks to the achievement of the technical, schedule and cost aspects of the contract and assess the effects of those risks on our estimates of total costs to complete the contract. The estimates consider the technical requirements (e.g., a newly-developed product versus a mature product), the schedule and associated tasks (e.g., the number and type of milestone events) and costs (e.g., material, labor, subcontractor, overhead and the estimated costs to fulfill our industrial cooperation agreements, sometimes referred to as offset agreements, required under certain contracts with international customers). The initial profit booking rate of each contract considers risks surrounding the ability to achieve the technical requirements, schedule and costs in the initial estimated total costs to complete the contract. Profit booking rates may increase during the performance of the contract if we successfully retire risks surrounding the technical, schedule and cost aspects of the contract, which decreases the estimated total costs to complete the contract. Conversely, our profit booking rates may decrease if the estimated total costs to complete the contract increase. All of the estimates are subject to change during the performance of the contract and may affect the profit booking rate.
 
Comparability of our segment sales, operating profit and operating margin may be impacted favorably or unfavorably by changes in profit booking rates on our contracts accounted for using the percentage-of-completion method of accounting. Increases in the profit booking rates, typically referred to as risk retirements, usually relate to revisions in the estimated total costs that reflect improved conditions on a particular contract. Conversely, conditions on a particular contract may deteriorate, resulting in an increase in the estimated total costs to complete and a reduction in the profit booking rate. Increases or decreases in profit booking rates are recognized in the current period and reflect the inception-to-date effect of such changes. Segment operating profit and margin may also be impacted favorably or unfavorably by other items. Favorable items may include the positive resolution of contractual matters, cost recoveries on restructuring charges, insurance recoveries and gains on sales of assets. Unfavorable items may include the adverse resolution of contractual matters; restructuring charges, except for significant severance actions, which are excluded from segment operating results; reserves for disputes; certain asset impairments; and losses on sales of certain assets. Segment operating profit and items such as risk retirements, reductions of profit booking rates or other matters are presented net of state income taxes.
As previously disclosed, we have a program, EADGE-T, to design, integrate, and install an air missile defense command, control, communications, computers – intelligence (C4I) systems for an international customer that has experienced performance matters and for which we have periodically accrued reserves. During the first quarter of 2017, we revised our estimated costs to complete EADGE-T as a consequence of ongoing performance matters and recorded an additional charge of $120 million ($74 million or $0.25 per share, after tax) at our RMS business segment. As of September 24, 2017, cumulative losses, including reserves, remained at approximately $260 million on this program. We are continuing to monitor the viability of the program and the available options and could record additional charges in future periods. However, based on the reserves already accrued and our current estimate of the costs to complete the program, at this time we do not anticipate that additional charges, if any, would be material.
We have certain commercial satellite programs at our Space Systems business segment, where we have experienced performance matters related to the development and integration of the enhanced and modernized A2100 satellite platform. These commercial programs represent the development of new satellite technology to enhance the A2100’s power, propulsion and electronics, among other items, which is expected to benefit other commercial and government satellite programs. We have periodically revised our estimated costs to complete these programs. As previously reported, we recorded cumulative losses of approximately $260 million through June 25, 2017, including approximately $90 million recorded during the six months ended June 25, 2017. While the loss reflected our estimated total losses on the programs at that time, we continue to monitor any changes to the scope and estimated costs of these programs and may have to record additional loss reserves in future periods, which could be material to our operating results.
Our consolidated net adjustments not related to volume, including net profit booking rate adjustments and other matters, net of state income taxes, increased segment operating profit by approximately $330 million and $1.1 billion in the quarter and nine months ended September 24, 2017 and $405 million and $1.1 billion in the quarter and nine months ended September 25, 2016. These adjustments increased net earnings by approximately $214 million ($0.74 per share) and $718 million ($2.46 per share) in the quarter and nine months ended September 24, 2017 and $265 million ($0.88 per share) and $730 million ($2.39 per share) in the quarter and nine months ended September 25, 2016.

21


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

Restructuring Charges
During the first quarter of 2016, we recorded severance charges totaling approximately $80 million related to our Aeronautics business segment. The charges consisted of severance costs associated with the planned elimination of certain positions through either voluntary or involuntary actions. Upon separation, terminated employees received lump-sum severance payments primarily based on years of service. As of the end of the first quarter of 2017, we had substantially paid the severance cost associated with these actions.
Equity Method Investee Impairment
During the nine months ended September 24, 2017, equity earnings included a charge recorded in the first quarter of approximately $64 million ($40 million or $0.14 per share, after tax), which represented our portion of a noncash asset impairment related to certain long-lived assets held by our equity method investee, AMMROC. We are continuing to monitor this investment. It is possible that we may have to record our portion of additional charges should their business continue to experience performance issues, which could adversely affect our business, financial condition and results of operations.
Sales of Customer Receivables
On occasion, our customers may seek deferred payment terms to purchase our products. In connection with these transactions, we may enter into arrangements for the non-recourse sale of customer receivables to unrelated third–party financial institutions. For accounting purposes, these transactions are treated as a sale of receivables and the sale proceeds from the financial institutions are reflected in our operating cash flows on the statement of cash flows. During the quarter and nine months ended September 24, 2017, we sold approximately $146 million and $511 million of customer receivables. There were no gains or losses related to sales of these receivables.
Revolving Credit Facility Extension
In October 2017, our $2.5 billion revolving credit facility (the 5-year Facility) was amended to extend its expiration date by one year from October 9, 2021 to October 9, 2022.
Long-Term Debt
In September 2017, we issued notes totaling approximately $1.6 billion with a fixed interest rate of 4.09% maturing in September 2052 (the New Notes) in exchange for outstanding notes totaling approximately $1.4 billion with fixed interest rates ranging from 4.70% to 8.50% maturing 2029 to 2046 (the Old Notes). In connection with the exchange of principal, we paid a premium of $237 million, substantially all of which was in the form of New Notes. This premium will be amortized as additional interest expense over the term of the New Notes using the effective interest method. We may, at our option, redeem some or all of the New Notes at any time by paying the principal amount of notes being redeemed plus a make-whole premium and accrued and unpaid interest. Interest on the New Notes is payable on March 15 and September 15 of each year, beginning on March 15, 2018. The New Notes are unsecured senior obligations and rank equally in right of payment with all of our existing and future unsecured and unsubordinated indebtedness.
In September 2016, we repaid $500 million of long-term notes with a fixed interest rate of 2.13% according to their scheduled maturities. In May 2016, we repaid $452 million of long-term notes with a fixed interest rate of 7.65% according to their scheduled maturities. We also had related variable interest rate swaps with a notional amount of $450 million mature, which did not have a significant impact on net earnings or comprehensive income.
Income Taxes
Our effective income tax rates were 25.4% and 26.1% for the quarter and nine months ended September 24, 2017, and 23.7% and 23.1% for the quarter and nine months ended September 25, 2016. The rates for both periods benefited from tax deductions for U.S. manufacturing activities, dividends paid to our defined contribution plans with an employee stock ownership plan feature, tax deductions for employee equity awards, and the research and development tax credit. The rates in the quarter and nine months ended September 25, 2016 also benefited from the nontaxable gain recorded in connection with the increase in AWE ownership.

22


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

Recent Accounting Pronouncements
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, as amended (Topic 606) (commonly referred to as ASC 606), which will change the way we recognize revenue and significantly expand the disclosure requirements for revenue arrangements. We will adopt the requirements of the new standard on the effective date of January 1, 2018 using the full retrospective transition method, whereby ASC 606 will be applied to each prior year presented and the cumulative effect of applying ASC 606 will be recognized at January 1, 2016, the beginning of the earliest year presented.
As ASC 606 supersedes substantially all existing revenue guidance affecting us under current GAAP, it will impact revenue and cost recognition across all of our business segments, as well as our business processes and our information technology systems. We do not expect our adoption of ASC 606 to impact our cash flows.
We commenced our evaluation of the impact of ASC 606 in late 2014, by evaluating its impact on selected contracts at each of our business segments. With this baseline understanding, we developed a project plan to evaluate thousands of contracts across our business segments, develop processes and tools to dual report financial results under both current GAAP and ASC 606 and assess the internal control structure in order to adopt ASC 606 on January 1, 2018. We have periodically briefed our Audit Committee on our progress made towards adoption.
We currently recognize the majority of our revenue using the percentage-of-completion method of accounting, whereby revenue is recognized as we progress on the contract. For contracts with a significant amount of development and/or requiring the delivery of a minimal number of units, revenue and profit are recognized using the percentage-of-completion cost-to-cost method to measure progress. For example, we use this method at our Aeronautics business segment for the F-35 program; at our MFC business segment for the THAAD program; at our RMS business segment for the Littoral Combat Ship and Aegis Combat System programs; and at our Space Systems business segment for government satellite programs. For contracts that require us to produce a substantial number of similar items without a significant level of development, we currently record revenue and profit using the percentage-of-completion units-of-delivery method as the basis for measuring progress on the contract. For example, we use this method in Aeronautics for the C-130J and C-5 programs; in MFC for tactical missile programs (e.g., Hellfire, JASSM), PAC-3 programs and fire control programs (e.g., LANTIRN®, Sniper®); in RMS for Black Hawk and Seahawk helicopter programs; and in Space Systems for commercial satellite programs. For contracts to provide services to the U.S. Government, revenue is generally recorded using the percentage-of-completion cost-to-cost method.
Under ASC 606, revenue will be recognized as the customer obtains control of the goods and services promised in the contract (i.e., performance obligations). Given the nature of our products and terms and conditions in our contracts, in particular those with the U.S. Government (including foreign military sales (FMS) contracts), the customer obtains control as we perform work under the contract. Therefore, we expect to recognize revenue over time for substantially all of our contracts using a method similar to our current percentage-of-completion cost-to-cost method. Accordingly, adoption of ASC 606 will primarily impact our contracts where revenue is currently recognized using the percentage-of-completion units-of-delivery method. As a result, we anticipate recognizing revenue for these contracts earlier in the performance period as we incur costs, as opposed to when units are delivered. We may also have more performance obligations in our contracts under ASC 606, which may impact the timing of recording sales and operating profit, including those where sales recognition is deferred pending the incurrence of costs. Backlog will also be impacted upon our adoption to reflect these changes and the requirements of ASC 606. 
During the third quarter of 2017, we completed our preliminary assessment of the cumulative effect of adopting ASC 606 on our December 31, 2015 balance sheet using the full retrospective transition method. The adoption resulted in a decrease in inventories, an increase in billed receivables, contract assets (i.e., unbilled receivables) and contract liabilities (i.e., customer advances and amounts in excess of costs incurred) to primarily reflect the impact of converting contracts currently applying the units-of-delivery method to the cost-to-cost method for recognizing revenue and profits. We expect the net impact of these reclassifications to increase both our current assets and current liabilities by approximately 2%.
In addition, we completed our preliminary assessment of adopting ASC 606 on our fiscal year 2016 operating results during the third quarter of 2017. We expect the adoption of ASC 606 to increase our 2016 net sales by approximately less than 1% and decrease our operating profit and net earnings from continuing operations each by approximately less than 2%.

23


Lockheed Martin Corporation
Notes to Consolidated Financial Statements (unaudited) (continued)

The impact of adopting ASC 606 on our 2016 operating results may not be indicative of the adoption impacts in future periods or of our operating performance. We will continue our evaluation of ASC 606, including any new interpretations, through the date of adoption.
In August 2017, the FASB issued ASU No. 2017-12, Derivatives and Hedging (Topic 815), which eliminates the requirement to separately measure and report hedge ineffectiveness. The guidance is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. We do not expect a significant impact to our consolidated assets and liabilities, net earnings, or cash flows as a result of adopting this new standard. We plan to adopt the new standard January 1, 2019.

In March 2017, the FASB issued ASU No. 2017-07, Compensation-Retirement Benefits (Topic 715), which changes the income statement presentation of certain components of net periodic benefit cost related to defined benefit pension and other postretirement benefit plans. Currently, we record all components of net periodic benefit costs in operating profit as part of cost of sales. Under ASU 2017-07, we will be required to record only the service component of net periodic benefit cost in operating profit and the non-service components of net periodic benefit cost (i.e., interest cost, expected return on plan assets, amortization of prior service cost or credits, and net actuarial gains or losses) as part of non-operating income. We plan to adopt the requirements of ASU 2017-07 on January 1, 2018 using the retrospective transition method. We expect the adoption of ASU 2017-07 to result in an increase to consolidated operating profit of $471 million and $846 million for 2016 and 2017, respectively, and a corresponding decrease in non-operating income for each year. We do not expect any impact to our business segment operating profit, our consolidated net earnings, or cash flows as a result of adopting ASU 2017-07.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350), which eliminates the requirement to compare the implied fair value of reporting unit goodwill with the carrying amount of that goodwill (i.e., commonly referred to as Step 2) from the current goodwill impairment test. The new standard does not change how a goodwill impairment is identified. We will continue to perform our quantitative and qualitative goodwill impairment test by comparing the fair value of each reporting unit to its carrying amount, but if we are required to recognize a goodwill impairment charge, under the new standard the amount of the charge will be calculated by subtracting the reporting unit’s fair value from its carrying amount. Under the current standard, if we are required to recognize a goodwill impairment charge, Step 2 requires us to calculate the implied value of goodwill by assigning the fair value of a reporting unit to all of its assets and liabilities as if that reporting unit had been acquired in a business combination and the amount of the charge is calculated by subtracting the reporting unit’s implied fair value of goodwill from its actual goodwill balance. The new standard is effective for interim and annual reporting periods beginning after December 15, 2019, with early adoption permitted, and should be applied prospectively from the date of adoption. We elected to adopt the new standard for future goodwill impairment tests at the beginning of the third quarter of 2017, because it significantly simplifies the evaluation of goodwill for impairment. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” (under the caption "Critical Accounting Policies") for additional information. The impact of the new standard will depend on the outcomes of future goodwill impairment tests.
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which requires the recognition of lease assets and lease liabilities on the balance sheet and disclosure of key information about leasing arrangements for both lessees and lessors. The new standard is effective January 1, 2019 for public companies, with early adoption permitted. The new standard will be applied using a modified retrospective approach to the beginning of the earliest period presented in the financial statements. We are continuing to evaluate the expected impact to our consolidated financial statements and related disclosures. We plan to adopt the new standard effective January 1, 2019.

24


Review Report of Ernst & Young LLP,
Independent Registered Public Accounting Firm
Board of Directors
Lockheed Martin Corporation
We have reviewed the consolidated balance sheet of Lockheed Martin Corporation as of September 24, 2017, and the related consolidated statements of earnings and comprehensive income for the quarters and nine months ended September 24, 2017 and September 25, 2016, and the consolidated statements of cash flows and equity for the nine months ended September 24, 2017 and September 25, 2016. These financial statements are the responsibility of the Corporation’s management.
We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should be made to the consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Lockheed Martin Corporation as of December 31, 2016, and the related consolidated statements of earnings, comprehensive income, cash flows, and equity for the year then ended (not presented herein), and we expressed an unqualified audit opinion on those consolidated financial statements in our report dated February 9, 2017. In our opinion, the accompanying consolidated balance sheet as of December 31, 2016, is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ Ernst & Young LLP
Tysons, Virginia
October 26, 2017


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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
BUSINESS OVERVIEW
We are a global security and aerospace company principally engaged in the research, design, development, manufacture, integration and sustainment of advanced technology systems, products and services. We also provide a broad range of management, engineering, technical, scientific, logistics, system integration and cybersecurity services. We serve both U.S. and international customers with products and services that have defense, civil and commercial applications, with our principal customers being agencies of the U.S. Government. In 2016, 71% of our $47.2 billion in net sales were from the U.S. Government, either as a prime contractor or as a subcontractor (including 59% from the Department of Defense (DoD)), 27% were from international customers (including foreign military sales (FMS) contracted through the U.S. Government) and 2% were from U.S. commercial and other customers. Our main areas of focus are in defense, space, intelligence, homeland security and information technology, including cybersecurity.
Business Developments
On August 16, 2016, we divested our former Information Systems & Global Solutions (IS&GS) business, which merged with Leidos Holdings, Inc. (Leidos) in a Reverse Morris Trust transaction. Accordingly, the operating results of the IS&GS business for the quarter and nine months ended September 25, 2016 have been classified as discontinued operations in the consolidated statements of earnings. However, the cash flows of the IS&GS business for the nine months ended September 25, 2016 have not been reclassified in our consolidated statement of cash flows as we retained the cash as part of the transaction. See “Note 3 – Divestiture” included in our Notes to Consolidated Financial Statements for additional information.
On August 24, 2016, we increased our ownership interest in the AWE Management Limited (AWE) joint venture from 33% to 51%, at which time we began consolidating AWE. Consequently, our operating results for the quarter and nine months ended September 24, 2017 include 100% of AWE’s sales and 51% of its operating profit. Prior to increasing our ownership interest, we accounted for our investment in AWE using the equity method of accounting. Under the equity method, we recognized only 33% of AWE’s earnings or losses and no sales. Accordingly, prior to August 24, 2016, the date we obtained control, we recorded 33% of AWE's net earnings in our operating results and subsequent to August 24, 2016, we recognized 100% of AWE's sales and 51% of its operating profit. Additionally, during the quarter and nine months ended September 25, 2016, we recorded a gain of $104 million associated with obtaining control of AWE, which consisted of a $127 million pre-tax gain recognized in the operating results of our Space Systems business segment and $23 million of deferred tax liabilities recorded at our corporate office.
2017 Financial Outlook and 2018 Financial Trends
We expect 2017 net sales to increase in the mid-single digit percentage range from 2016 levels. The projected growth is driven by increased production and sustainment volume on the F-35 program at Aeronautics as well as increased volume at Missiles and Fire Control (MFC) and Rotary and Mission Systems (RMS), partially offset by a slight decrease in volume at Space Systems. We expect segment operating profit margin to be just above 10% compared to the 2016 margin of 10.8%, primarily driven by lower AWE earnings as a result of the non-cash gain recognized in 2016 related to the consolidation of AWE, amortization of AWE intangible assets in 2017, lower equity earnings at Space Systems, and a charge recorded in the first quarter of 2017 related to EADGE-T at RMS. We expect full year diluted earnings per share to increase to a range of $12.85 per share to $13.15 per share. The increase is driven primarily by a previously deferred non-cash gain of approximately $200 million that we expect to recognize in the fourth quarter, in other income, net at our corporate office related to properties sold in 2015. Recognition of this gain is expected to increase net earnings from continuing operations by $120 million, or $0.40 per share.

26


Effective January 1, 2018, we will adopt Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers, as amended (commonly referred to as ASC 606), which will change the way we recognize revenue for certain customer contracts. During the third quarter of 2017, we completed a preliminary assessment of the impacts of adopting ASC 606 on our 2017 financial outlook. The following table presents our updated 2017 outlook under the current revenue recognition accounting standard (ASC 605) and our preliminary estimate under ASC 606. We are providing this information to assist in understanding our 2018 trend information in the following paragraphs. Additional information regarding the impacts of adopting ASC 606 can be found in "Note 10 - Other" included in our Notes to Consolidated Financial Statements (under the caption "Recent Accounting Pronouncements").
 
 
2017 Financial Outlook
 
(in millions)
 
ASC 605
 
ASC 606
 
Net sales
 
$50,000 – $51,200
 
$49,000 – $50,200
 
Business segment operating profit
 
$5,040 – $5,160
 
$5,040 – $5,160
 
FAS/CAS pension adjustment
 
~880
 
~880
 
Property sale gain (a)
 
~200
 
~200
 
Other, net
 
~(305)
 
~(305)
 
Consolidated operating profit (a)
 
$5,815 – $5,935
 
$5,815 – $5,935
 
Cash from operations
 
≥ $6,200
 
≥ $6,200
 
(a) 
In the fourth quarter of 2017, the corporation expects to recognize a previously deferred non-cash gain of approximately $200 million related to properties sold in 2015, which is expected to increase net earnings from continuing operations by $120 million ($0.40 per share).

We expect our 2018 net sales to increase by approximately 2% as compared to 2017 net sales adjusted for the adoption of ASC 606 presented in the preceding table. Total business segment operating margin in 2018 is expected to be in the 10.3% to 10.5% range and cash from operations is expected to be greater than or equal to $5.0 billion. The preliminary outlook for 2018 assumes the U.S. Government continues to support and fund our key programs beyond the continuing resolution for government fiscal year (GFY) 2018. Changes in circumstances may require us to revise our assumptions, which could materially change our current estimate of 2018 net sales, operating margin and cash flows.

We expect the net 2018 FAS/CAS pension adjustment to be approximately $860 million assuming a 3.875% discount rate (a 25 basis point decrease from the end of 2016), a 9.00% return on plan assets in 2017 (a 150 basis point increase from the expected rate of return at the end of 2016), and a 7.50% expected long-term rate of return on plan assets in future years, among other assumptions. A change of plus or minus 25 basis points to the assumed discount rate, with all other assumptions held constant, would result in an incremental increase or decrease of approximately $115 million to the estimated net 2018 FAS/CAS pension adjustment. A change of plus or minus 100 basis points to the return on plan assets in 2017 only, with all other assumptions held constant, would increase or decrease the net 2018 FAS/CAS pension adjustment by approximately $20 million. We will finalize the postretirement benefit plan assumptions and determine the 2017 actual return on plan assets on December 31, 2017. The final assumptions and actual investment return for 2017 may differ materially from those discussed above. We expect to make contributions of $1.6 billion to our qualified defined benefit pension plans in 2018.
The following discussion is a supplement to and should be read in conjunction with the accompanying consolidated financial statements and notes thereto and with our Annual Report on Form 10-K for the year ended December 31, 2016 (2016 Form 10-K).

27


INDUSTRY CONSIDERATIONS
U.S. Government Funding
The U.S. Government has not yet passed an appropriations bill for fiscal year 2018 (the U.S. Government’s fiscal year begins on October 1 and ends on September 30). However, on September 8, 2017, the U.S. Government passed a continuing resolution funding measure to finance all U.S. Government activities through December 8, 2017. Under this continuing resolution, partial-year funding at amounts consistent with appropriated levels for fiscal year 2017 are available, subject to certain restrictions, but new spending initiatives are not authorized. Our key programs continue to be supported and funded despite the continuing resolution financing mechanism. However, during periods covered by continuing resolutions or until the regular appropriation bills are passed, we may experience delays in procurement of products and services due to lack of funding, and those delays may affect our results of operations.
In May 2017, the President submitted a budget proposal for GFY 2018 to Congress, which includes a base budget for the DoD of $575 billion, approximately $52 billion above the spending limits established under the Budget Control Act of 2011 (the Budget Control Act) (described below) and an increase of $32 billion over the fiscal year 2017 funding level. The President’s budget requests also includes funding of $65 billion for Overseas Contingency Operations (OCO) / Global War on Terror (GWOT), which is not subject to the Budget Control Act spending limits. Congress must approve or revise the President’s GFY 2018 budget proposals through enactment of appropriations bills and other policy legislation, which would then require final Presidential approval.

Both the House and Senate have passed versions of the 2018 National Defense Authorization bills, which establish funding levels for the agencies responsible for defense and set forth how the funds will be used. Each of these proposals reflect significant increases over the President’s $575 billion request. These two positions must now be reconciled in conference. It remains uncertain which measures will be adopted in the final National Defense Authorization Act and when an appropriations bill for fiscal year 2018 will be enacted or at what levels.
Currently, U.S. defense spending through fiscal year 2021 remains subject to statutory spending limits established by the Budget Control Act. The spending limits were modified for fiscal years 2013 through 2017 by the American Taxpayer Relief Act of 2012, the Bipartisan Budget Act of 2013 and the Bipartisan Budget Act of 2015. However, these acts did not provide relief to the spending limits beyond fiscal year 2017. If Congress approves the President’s budget proposal or other appropriation legislation with funding levels that exceed the spending limits, automatic across-the-board spending reductions, known as sequestration, would be triggered to reduce funding back to the spending limits. As currently enacted, the Budget Control Act limits defense spending to $522 billion for fiscal year 2018 with modest increases of about 2.5% per year through 2021. The President’s budget proposal as well as defense budget estimates for fiscal year 2018 and beyond exceed the spending limits established by the Budget Control Act. As a result, continued budget uncertainty and the risk of future sequestration cuts remain unless the Budget Control Act is repealed or significantly modified. The investments and acquisitions we have made in recent years have sought to align our businesses with what we believe are the most critical national priorities and mission areas. However, the possibility remains that our programs could be materially reduced, extended, or terminated as a result of the U.S. Government’s continuing assessment of priorities, changes in government priorities, the implementation of sequestration (particularly in those circumstances where sequestration is implemented across-the-board without regard to national priorities), or other budget cuts in lieu of sequestration.
In March 2017, the outstanding debt of the U.S. reached the debt borrowing limit, known as the debt ceiling, and the U.S. Department of Treasury began employing measures to finance the U.S. Government to avoid exceeding the debt ceiling. On September 8, 2017, Congress passed legislation suspending the debt ceiling through December 8, 2017.  Effective on December 9, 2017, the debt limit will be increased to the amount of debt the government holds outstanding on that date. However, despite using cash on hand and measures employed by the Department of Treasury, the debt ceiling is expected to be reached again in early 2018. Congress will need to raise the debt limit in order for the U.S. Government to continue borrowing money before these measures are exhausted. If the debt ceiling is not raised, the U.S. Government may not be able to pay for expenditures or fulfill its funding obligations and there could be significant disruption to all discretionary programs.

28


We anticipate there will continue to be a significant amount of debate and negotiations within the U.S. Government over defense spending and the debt ceiling. In the context of these negotiations, it is possible that existing cuts to government programs could be kept in place, replaced with different spending cuts, and/or replaced with a package of broader reforms to reduce the federal deficit. However, we continue to believe that our portfolio of products and services will continue to be well supported in a strategically focused allocation of budget resources.
CONSOLIDATED RESULTS OF OPERATIONS
Since our operating cycle is primarily long-term and involves many types of contracts for the design, development and manufacture of products and related activities with varying delivery schedules, the results of operations of a particular period, or period-to-period comparisons of sales and profits, may not be indicative of future operating results. The following discussions of comparative results among periods should be reviewed in this context. All per share amounts cited in these discussions are presented on a “per diluted share” basis, unless otherwise noted. Our consolidated results of operations were as follows (in millions, except per share data):
 
 
Quarters Ended
 
Nine Months Ended
  
 
September 24,
2017
 
September 25,
2016
 
September 24,
2017
 
September 25,
2016
Net sales
 
$
12,169

 
 
$
11,551

 
 
$
35,911

 
 
$
33,496

 
Cost of sales
 
(10,818
)
 
 
(10,167
)
 
 
(31,982
)
 
 
(29,787
)
 
Gross profit
 
1,351

 
 
1,384

 
 
3,929

 
 
3,709

 
Other income, net
 
77

 
 
204

 
 
133

 
 
412

 
Operating profit
 
1,428

 
 
1,588

 
 
4,062

 
 
4,121

 
Interest expense
 
(162
)
 
 
(162
)
 
 
(477
)
 
 
(492
)
 
Other non-operating (expense) income, net
 
(7
)
 
 
1

 
 
(8
)
 
 
2

 
Earnings from continuing operations before income taxes
 
1,259

 
 
1,427

 
 
3,577

 
 
3,631

 
Income tax expense
 
(320
)
 
 
(338
)
 
 
(933
)
 
 
(837
)
 
Net earnings from continuing operations
 
939

 
 
1,089

 
 
2,644

 
 
2,794

 
Net earnings from discontinued operations
 

 
 
1,306

 
 

 
 
1,520

 
Net earnings
 
$
939

 
 
$
2,395

 
 
$
2,644

 
 
$
4,314

 
Diluted earnings per common share