Edgar Filing: LOCKHEED MARTIN CORP

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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 June 24, 2018

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 every Interactive Data File required to be submitted 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 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 284,781,066 shares of our common stock, $1 par value per share, outstanding as of June 24, 2018.

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Lockheed Martin Corporation

Form 10-Q

For the Quarterly Period Ended June 24, 2018

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			Page

PART I. FINANCIAL INFORMATION

	ITEM 1.	Financial Statements

		Consolidated Statements of Earnings for the Quarters and Six Months Ended June 24, 2018 and June 25, 2017	3

		Consolidated Statements of Comprehensive Income for the Quarters and Six Months Ended June 24, 2018 and June 25, 2017	4

		Consolidated Balance Sheets as of June 24, 2018 and December 31, 2017	5

		Consolidated Statements of Cash Flows for the Six Months Ended June 24, 2018 and June 25, 2017	6

		Consolidated Statements of Equity for the Six Months Ended June 24, 2018 and June 25, 2017	7

		Notes to Consolidated Financial Statements	8

		Report of Independent Registered Public Accounting Firm	32

	ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	33

	ITEM 3.	Quantitative and Qualitative Disclosures About Market Risk	49

	ITEM 4.	Controls and Procedures	49

PART II. OTHER INFORMATION

	ITEM 1.	Legal Proceedings	51

	ITEM 1A.	Risk Factors	51

	ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	52

	ITEM 6.	Exhibits	53

SIGNATURE			54

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PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

Lockheed Martin Corporation

Consolidated Statements of Earnings

(unaudited; in millions, except per share data)



	Quarters Ended						Six Months Ended
	June 24, 2018			June 25, 2017			June 24, 2018			June 25, 2017
Net sales
Products	$	11,150		$	10,622		$	20,912		$	20,235
Services	2,248			1,941			4,121			3,540
Total net sales	13,398			12,563			25,033			23,775
Cost of sales
Products	(9,993		)	(9,562		)	(18,690		)	(18,306		)
Services	(1,967		)	(1,706		)	(3,656		)	(3,140		)
Severance and restructuring charges	(96		)	—			(96		)	—
Other unallocated, net	411			361			820			733
Total cost of sales	(11,645		)	(10,907		)	(21,622		)	(20,713		)
Gross profit	1,753			1,656			3,411			3,062
Other income, net	42			60			109			56
Operating profit	1,795			1,716			3,520			3,118
Interest expense	(165		)	(160		)	(320		)	(315		)
Other non-operating expense, net	(210		)	(214		)	(420		)	(426		)
Earnings before income taxes	1,420			1,342			2,780			2,377
Income tax expense	(257		)	(387		)	(460		)	(633		)
Net earnings	$	1,163		$	955		$	2,320		$	1,744

Earnings per common share
Basic	$	4.08		$	3.31		$	8.13		$	6.03
Diluted	$	4.05		$	3.28		$	8.07		$	5.97
Cash dividends paid per common share	$	2.00		$	1.82		$	4.00		$	3.64

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

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Lockheed Martin Corporation

Consolidated Statements of Comprehensive Income

(unaudited; in millions)



	Quarters Ended					Six Months Ended
	June 24, 2018			June 25, 2017		June 24, 2018			June 25, 2017
Net earnings	$	1,163		$	955	$	2,320		$	1,744
Other comprehensive income, net of tax
Postretirement benefit plans
Amounts reclassified from accumulated other comprehensive loss	300			200		600			402
Other comprehensive gain recognized during the period	—			—		—			3
Other, net	(106		)	55		(48		)	60
Other comprehensive income, net of tax	194			255		552			465
Comprehensive income	$	1,357		$	1,210	$	2,872		$	2,209

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

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Lockheed Martin Corporation

Consolidated Balance Sheets

(unaudited; in millions, except par value)



	June 24, 2018			December 31, 2017
Assets
Current assets
Cash and cash equivalents	$	1,181		$	2,861
Receivables, net	2,482			2,265
Contract assets	9,281			7,992
Inventories	3,038			2,878
Other current assets	522			1,509
Total current assets	16,504			17,505
Property, plant and equipment, net	5,786			5,775
Goodwill	10,781			10,807
Intangible assets, net	3,646			3,797
Deferred income taxes	3,051			3,156
Other noncurrent assets	5,357			5,580
Total assets	$	45,125		$	46,620
Liabilities and equity
Current liabilities
Accounts payable	$	2,675		$	1,467
Contract liabilities	6,413			7,028
Salaries, benefits and payroll taxes	2,051			1,785
Current maturities of long-term debt	750			750
Other current liabilities	1,992			1,883
Total current liabilities	13,881			12,913
Long-term debt, net	13,479			13,513
Accrued pension liabilities	12,196			15,703
Other postretirement benefit liabilities	706			719
Other noncurrent liabilities	4,384			4,548
Total liabilities	44,646			47,396
Stockholders’ equity
Common stock, $1 par value per share	283			284
Additional paid-in capital	—			—
Retained earnings	14,528			11,405
Accumulated other comprehensive loss	(14,395		)	(12,539		)
Total stockholders’ equity (deficit)	416			(850		)
Noncontrolling interests in subsidiary	63			74
Total equity (deficit)	479			(776		)
Total liabilities and equity	$	45,125		$	46,620

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

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Lockheed Martin Corporation

Consolidated Statements of Cash Flows

(unaudited; in millions)



	Six Months Ended
	June 24, 2018			June 25, 2017
Operating activities
Net earnings	$	2,320		$	1,744
Adjustments to reconcile net earnings to net cash provided by operating activities
Depreciation and amortization	566			581
Stock-based compensation	98			101
Severance and restructuring charges	96			—
Changes in assets and liabilities
Receivables, net	(217		)	(619		)
Contract assets	(1,289		)	(170		)
Inventories	(160		)	(38		)
Accounts payable	1,224			940
Contract liabilities	(615		)	(388		)
Postretirement benefit plans	(2,790		)	685
Income taxes	928			3
Other, net	399			371
Net cash provided by operating activities	560			3,210
Investing activities
Capital expenditures	(480		)	(448		)
Other, net	151			9
Net cash used for investing activities	(329		)	(439		)
Financing activities
Dividends paid	(1,156		)	(1,069		)
Repurchases of common stock	(610		)	(1,000		)
Other, net	(145		)	(87		)
Net cash used for financing activities	(1,911		)	(2,156		)
Net change in cash and cash equivalents	(1,680		)	615
Cash and cash equivalents at beginning of period	2,861			1,837
Cash and cash equivalents at end of period	$	1,181		$	2,452

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

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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, 2017	$	284		$	—		$	11,405		$	(12,539	)	$	(850	)	$	74		$	(776	)
Net earnings	—			—			2,320			—			2,320			—			2,320
Other comprehensive income, net of tax	—			—			—			552			552			—			552
Repurchases of common stock	(2		)	(161		)	(460		)	—			(623		)	—			(623		)
Dividends declared	—			—			(1,145		)	—			(1,145		)	—			(1,145		)
Stock-based awards, ESOP activity and other	1			161			—			—			162			—			162
Reclassification of income tax effects from tax reform	—			—			2,408			(2,408		)	—			—			—
Net decrease in noncontrolling interests in subsidiary	—			—			—			—			—			(11		)	(11		)
Balance at June 24, 2018	$	283		$	—		$	14,528		$	(14,395	)	$	416		$	63		$	479

Balance at December 31, 2016	$	289		$	—		$	13,195		$	(12,102	)	$	1,382		$	95		$	1,477
Net earnings	—			—			1,744			—			1,744			—			1,744
Other comprehensive income, net of tax	—			—			—			465			465			—			465
Repurchases of common stock	(4		)	(168		)	(828		)	—			(1,000		)	—			(1,000		)
Dividends declared	—			—			(1,585		)	—			(1,585		)	—			(1,585		)
Stock-based awards, ESOP activity and other	1			168			—			—			169			—			169
Net decrease in noncontrolling interests in subsidiary	—			—			—			—			—			(11		)	(11		)
Balance at June 25, 2017	$	286		$	—		$	12,526		$	(11,637	)	$	1,175		$	84		$	1,259

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

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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.

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 June 24 for the second quarter of 2018 and June 25 for the second quarter of 2017, 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.

Effective January 1, 2018, we adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, as amended (Topic 606) (commonly referred to as ASC 606), which changed the way we recognize revenue for certain contracts and significantly expanded disclosures about revenue recognition. In addition, effective January 1, 2018, we adopted ASU 2017-07, Compensation-Retirement Benefits, which changed the statement of earnings presentation of certain components of pension and other postretirement benefit plan expense. The amounts for all periods presented in this Form 10-Q have been adjusted to reflect the new methods of accounting. See “Note 12 – Recent Accounting Pronouncements” for more information regarding the adoption of these standards.

Other than the changes in our accounting policies related to revenue recognition and the classification of certain components of FAS pension and other postretirement benefit plan expense, 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, 2017 (2017 Form 10-K) filed with the SEC.

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 2017 Form 10-K.

NOTE 2 – SIGNIFICANT ACCOUNTING POLICY UPDATES

As described in “Note 1 – Basis of Presentation” and “Note 12 – Recent Accounting Pronouncements,” effective January 1, 2018, we adopted ASC 606, which changed the way we recognize revenue for certain contracts. Accounting policies that were significantly affected by the adoption of ASC 606 are discussed below.

Revenue Recognition

The majority of our net sales are generated from long-term contracts with the U.S. Government and international customers (including foreign military sales (FMS) contracted through the U.S. Government) for the research, design, development, manufacture, integration and sustainment of advanced technology systems, products and services. We provide our products and services under fixed-price and cost-reimbursable contracts.

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Lockheed Martin Corporation

Notes to Consolidated Financial Statements (unaudited) (continued)

Under fixed-price contracts we agree to perform the specified work for a pre-determined price. To the extent our actual costs vary from the estimates upon which the price was negotiated, we will generate more or less profit or could incur a loss. Some fixed-price contracts have a performance-based component under which we may earn incentive payments or incur financial penalties based on our performance.

Cost-reimbursable contracts provide for the payment of allowable costs incurred during performance of the contract plus a fee up to a ceiling based on the amount that has been funded. Typically, we enter into three types of cost-reimbursable contracts: cost-plus-award-fee, cost-plus-incentive-fee, and cost-plus-fixed-fee. Cost-plus-award-fee contracts provide for an award fee that varies within specified limits based on the customer’s assessment of our performance against a predetermined set of criteria, such as targets based on cost, quality, technical and schedule criteria. Cost-plus-incentive-fee contracts provide for reimbursement of costs plus a fee, which is adjusted by a formula based on the relationship of total allowable costs to total target costs (i.e., incentive based on cost) or reimbursement of costs plus an incentive to exceed stated performance targets (i.e., incentive based on performance). The fixed-fee in a cost-plus-fixed-fee contract is negotiated at the inception of the contract and that fixed-fee does not vary with actual costs.

We account for a contract after it has been approved by all parties to the arrangement, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.

We assess each contract at its inception to determine whether it should be combined with other contracts. When making this determination, we consider factors such as whether two or more contracts were negotiated and executed at or near the same time or were negotiated with an overall profit objective. If combined, we treat the combined contracts as a single contract for revenue recognition purposes.

We evaluate the products or services promised in each contract at inception to determine whether the contract should be accounted for as having one or more performance obligations. The products and services in our contracts are typically not distinct from one another due to their complex relationships and the significant contract management functions required to perform under the contract. Accordingly, our contracts are typically accounted for as one performance obligation. In limited cases, our contracts have more than one distinct performance obligation, which occurs when we perform activities that are not highly complex or interrelated or involve different product lifecycles. Significant judgment is required in determining performance obligations, and these decisions could change the amount of revenue and profit recorded in a given period. We classify net sales as products or services on our consolidated statements of earnings based on the predominant attributes of the performance obligations.

We determine the transaction price for each contract based on the consideration we expect to receive for the products or services being provided under the contract. For contracts where a portion of the price may vary we estimate variable consideration at the most likely amount, which is included in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur. We analyze the risk of a significant revenue reversal and if necessary constrain the amount of variable consideration recognized in order to mitigate this risk.

At the inception of a contract we estimate the transaction price based on our current rights and do not contemplate future modifications (including unexercised options) or follow-on contracts until they become legally enforceable. Contracts are often subsequently modified to include changes in specifications, requirements or price, which may create new or change existing enforceable rights and obligations. Depending on the nature of the modification, we consider whether to account for the modification as an adjustment to the existing contract or as a separate contract. Generally, modifications to our contracts are not distinct from the existing contract due to the significant integration and interrelated tasks provided in the context of the contract. Therefore, such modifications are accounted for as if they were part of the existing contract and recognized as a cumulative adjustment to revenue.

For contracts with multiple performance obligations, we allocate the transaction price to each performance obligation based on the estimated standalone selling price of the product or service underlying each performance obligation. The standalone selling price represents the amount we would sell the product or service to a customer on a standalone basis (i.e., not bundled with any other products or services). Our contracts with the U.S. Government, including FMS contracts, are subject to the Federal Acquisition Regulations (FAR) and the price is typically based on estimated or actual costs plus a reasonable profit margin. As a result of these regulations, the standalone selling price of products or services in our contracts with the U.S. Government and FMS contracts are typically equal to the selling price stated in the contract. Therefore, we typically do not need to allocate (or reallocate) the transaction price to multiple performance obligations.

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Lockheed Martin Corporation

Notes to Consolidated Financial Statements (unaudited) (continued)

For non-U.S. Government contracts with multiple performance obligations, we evaluate whether the stated selling prices for the products or services represent their standalone selling prices. We primarily sell customized solutions unique to a customer’s specifications. When it is necessary to allocate the transaction price to multiple performance obligations, we typically use the expected cost plus a reasonable profit margin to estimate the standalone selling price of each product or service. We occasionally sell standard products or services with observable standalone sales transactions. In these situations, the observable standalone sales transactions are used to determine the standalone selling price.

We recognize revenue as performance obligations are satisfied and the customer obtains control of the products and services. In determining when performance obligations are satisfied, we consider factors such as contract terms, payment terms and whether there is an alternative future use of the product or service. Substantially all of our revenue is recognized over a period of time as we perform under the contract because control of the work in process transfers continuously to the customer. For contracts with the U.S. Government and FMS contracts, this continuous transfer of control of the work in process to the customer is supported by clauses in the contract that allow the customer to unilaterally terminate the contract for convenience, pay us for costs incurred plus a reasonable profit, and take control of any work in process. Our non-U.S. Government contracts, primarily international direct commercial contracts, typically do not include termination for convenience provisions. However, continuous transfer of control to our customer is supported as, if our customer were to terminate the contract for reasons other than our non-performance, we would have the right to recover damages which would include, among other potential damages, the right to payment for our work performed to date plus a reasonable profit to deliver products or services that do not have an alternative use to us.

For performance obligations to deliver products with continuous transfer of control to the customer, revenue is recognized based on the extent of progress towards completion of the performance obligation, generally using the percentage-of-completion cost-to-cost measure of progress for our contracts because it best depicts the transfer of control to the customer as we incur costs on our contracts. Under the percentage-of-completion cost-to-cost measure of progress, the extent of progress towards completion is measured based on the ratio of costs incurred to date to the total estimated costs to complete the performance obligation(s). For performance obligations to provide services to the customer, revenue is recognized over a period of time based on costs incurred or the right to invoice method (in situations where the value transferred matches our billing rights) as our customer receives and consumes the benefits.

For performance obligations in which control does not continuously transfer to the customer, we recognize revenue at the point in time in which each performance obligation is fully satisfied. This coincides with the point in time the customer obtains control of the product or service, which typically occurs upon customer acceptance or receipt of the product or service, given that we maintain control of the product or service until that point.

Backlog (i.e., unfulfilled or remaining performance obligations) represents the sales we expect to recognize for our products and services for which control has not yet transferred to the customer. For our cost-reimbursable and fixed-priced-incentive contracts, the estimated consideration we expect to receive pursuant to the terms of the contract may exceed the contractual award amount. The estimated consideration is determined at the outset of the contract and is continuously reviewed throughout the contract period. In determining the estimated consideration, we consider the risks related to the technical, schedule and cost impacts to complete the contract and an estimate of any variable consideration. Periodically, we review these risks and may increase or decrease backlog accordingly. As the risks on such contracts are successfully retired, the estimated consideration from customers may be reduced, resulting in a reduction of backlog without a corresponding recognition of sales. As of June 24, 2018, our ending backlog was $105 billion. We expect to recognize approximately 40% over the next 12 months and approximately 65% over the next 24 months as revenue, with the remainder recognized thereafter.

For arrangements with the U.S. Government and FMS contracts, we generally do not begin work on contracts until funding is appropriated by the customer. Billing timetables and payment terms on our contracts vary based on a number of factors, including the contract type. Typical payment terms under fixed-price contracts with the U.S. Government provide that the customer pays either performance-based payments (PBPs) based on the achievement of contract milestones or progress payments based on a percentage of costs we incur. For the majority of our international direct commercial contracts to deliver complex systems, we typically receive advance payments prior to commencement of work, as well as milestone payments that are paid in accordance with the terms of our contract as we perform. We recognize a liability for payments in excess of revenue recognized, which is presented as a contract liability on the balance sheet. The portion of payments retained by the customer until final contract settlement is not considered a significant financing component because the intent is to protect the customer from our failure to adequately complete some or all of the obligations under the contract. Payments received from customers in advance of revenue recognition

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Lockheed Martin Corporation

Notes to Consolidated Financial Statements (unaudited) (continued)

are not considered to be significant financing components because they are used to meet working capital demands that can be higher in the early stages of a contract.

For fixed-price and cost-reimbursable contracts, we present revenues recognized in excess of billings as contract assets on the balance sheet. Amounts billed and due from our customers under both contract types are classified as receivables on the balance sheet.

Significant estimates and assumptions are made in estimating contract sales and costs, including the profit booking rate. At the outset of a long-term contract, we identify and monitor risks to the achievement of the technical, schedule and cost aspects of the contract, as well as variable consideration, and assess the effects of those risks on our estimates of sales and 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, general and administrative and the estimated costs to fulfill our industrial cooperation agreements, sometimes referred to as offset or localization 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 or may increase the variable consideration we expect to receive on the contract. Conversely, our profit booking rates may decrease if the estimated total costs to complete the contract increase or our estimates of variable consideration we expect to receive decrease. All of the estimates are subject to change during the performance of the contract and may affect the profit booking rate. When estimates of total costs to be incurred on a contract exceed total estimates of the transaction price, a provision for the entire loss is determined at the contract level and is recorded in the period in which the loss is determined.

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 for which we recognize revenue over a period of time using the percentage-of-completion cost-to-cost method to measure progress towards completion. Increases in the profit booking rates, typically referred to as risk retirements, usually relate to revisions in the estimated total costs to fulfill the performance obligations 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 fulfill the performance obligations 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, which may or may not impact sales. Favorable items may include the positive resolution of contractual matters, cost recoveries on severance and 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.

Our consolidated net adjustments not related to volume, including net profit booking rate adjustments and other matters, increased segment operating profit by approximately $465 million and $885 million during the quarter and six months ended June 24, 2018 and $515 million and $810 million during the quarter and six months ended June 25, 2017. These adjustments increased net earnings by approximately $367 million ($1.28 per share) and $699 million ($2.43 per share) during the quarter and six months ended June 24, 2018 and $335 million ($1.15 per share) and $527 million ($1.80 per share) during the quarter and six months ended June 25, 2017. We recognized net sales from performance obligations satisfied in prior periods of approximately $540 million and $955 million during the quarter and six months ended June 24, 2018 and $540 million and $920 million during the quarter and six months ended June 25, 2017, which primarily relate to changes in profit booking rates that impacted revenue.

We have a program, EADGE-T, to design, integrate, and install an air missile defense command, control, communications, computers – intelligence (C4I) system 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 the EADGE-T contract 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 Rotary and Mission Systems (RMS) business segment, which resulted in cumulative losses of approximately $260 million on this program. As of June 24, 2018, cumulative losses remained at approximately $260 million. We continue to monitor program requirements and our

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Lockheed Martin Corporation

Notes to Consolidated Financial Statements (unaudited) (continued)

performance. At this time, we do not anticipate additional charges that would be material to our operating results or financial condition.

We have two commercial satellite programs at our Space business segment, for which we have experienced performance issues related to the development and integration of a modernized LM 2100 satellite platform. These commercial programs require the development of new satellite technology to enhance the LM 2100’s power, propulsion and electronics, among other items. The enhanced LM 2100 satellite platform is expected to benefit other commercial and government satellite programs. We have periodically revised our estimated costs to complete these developmental commercial programs. We have recorded cumulative losses of approximately $380 million through June 24, 2018. During the quarter and six months ended June 24, 2018, we recorded losses of approximately $40 million ($30 million, or $0.10 per share, after tax) and $75 million ($56 million, or $0.20 per share, after tax). While these losses reflect our estimated total losses on the programs, we will continue to incur unrecoverable general and administrative costs each period until we complete these programs. These programs remain developmental and further challenges in the delivery and integration of new satellite technology, anomalies discovered during system testing requiring repair or rework, further schedule delays and potential penalties could require that we record additional loss reserves which could be material to our operating results. As we did not meet the July 2018 delivery requirement on one of the programs, the customer could seek to exercise a termination right, but we think that the probability that this will occur is remote as the customer has an immediate need for the satellites. Were the customer to seek to exercise a termination right and be successful in this effort, we would have to refund the payments we have received and pay certain penalties. On the other program, we currently anticipate delivering the satellite before the date upon which the customer could seek to exercise a termination right although we may have to pay certain penalties and have sought to address this possibility in our reserves.

We are responsible for designing, developing and installing an upgraded turret for the Warrior Capability Sustainment Program. During the six months ended June 24, 2018, as a consequence of performance issues, we revised our estimated costs to complete the program and recorded a reserve of $85 million ($64 million, or $0.22 per share, after tax) at our Missiles and Fire Control (MFC) business segment. As of June 24, 2018, we have recorded cumulative losses of approximately $140 million on this program. We may continue to experience issues related to customer requirements and our performance under this contract and have to record additional reserves. However, based on the losses already recorded and our current estimate of the sales and costs to complete the program, at this time we do not anticipate that additional losses, if any, would be material.

Receivables, Net

Receivables, net represent our unconditional right to consideration under the contract and include amounts billed and currently due from customers. The amounts are stated at their net estimated realizable value. There were no significant impairment losses related to our receivables during the quarters and six months ended June 24, 2018 and June 25, 2017.

On occasion, our customers may seek deferred payment terms to purchase our products. In connection with these transactions, we may, at our customer’s request, enter into arrangements for the non-recourse sale of customer receivables to unrelated third–party financial institutions. For accounting purposes, these transactions are not discounted and are treated as a sale of receivables as we have no continuing involvement. The sale proceeds from the financial institutions are reflected in our operating cash flows on the statement of cash flows. We sold customer receivables of $124 million and $227 million during the quarter and six months ended June 24, 2018 and $365 million during both the quarter and six months ended June 25, 2017. There were no gains or losses related to sales of these receivables.

Contract Assets

Contract assets include unbilled amounts typically resulting from sales under contracts when the percentage-of-completion cost-to-cost method of revenue recognition is utilized and revenue recognized exceeds the amount billed to the customer. The amounts may not exceed their estimated net realizable value. Contract assets are classified as current based on our contract operating cycle.

Inventories

We record inventories at the lower of cost or estimated net realizable value. If events or changes in circumstances indicate that the utility of our inventories have diminished through damage, deterioration, obsolescence, changes in price

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Lockheed Martin Corporation

Notes to Consolidated Financial Statements (unaudited) (continued)

or other causes, a loss is recognized in the period in which it occurs. We capitalize labor, material, subcontractor and overhead costs as work-in-process for contracts where control has not yet passed to the customer. In addition, we capitalize costs incurred to fulfill a contract in advance of contract award in inventories as work-in-process if we determine that contract award is probable. We determine the costs of other product and supply inventories by using the first-in first-out or average cost methods.

Contract Liabilities

Contract liabilities (formerly referred to as customer advances and amounts in excess of costs incurred) include advance payments and billings in excess of revenue recognized. Contract liabilities are classified as current based on our contract operating cycle and reported on a contract-by-contract basis, net of revenue recognized, at the end of each reporting period.

NOTE 3 – 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		Six Months Ended
	June 24, 2018	June 25, 2017	June 24, 2018	June 25, 2017
Weighted average common shares outstanding for basic computations	285.0	288.5	285.2	289.2
Weighted average dilutive effect of equity awards	2.1	2.7	2.3	2.8
Weighted average common shares outstanding for diluted computations	287.1	291.2	287.5	292.0

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 six months ended June 24, 2018 or June 25, 2017.

NOTE 4 – INFORMATION ON BUSINESS SEGMENTS

We operate in four business segments: Aeronautics, MFC, RMS and Space. We organize our business segments based on the nature of the products and services offered.

Net sales of our business segments exclude intersegment sales as these activities are eliminated in consolidation. Operating profit of our business segments includes our share of earnings or losses from equity method investees as the operating activities of the equity method investees are closely aligned with the operations of our business segments. In addition, operating profit of our business segments includes total pension costs recoverable on U.S. Government contracts as determined in accordance with U.S. Government cost accounting standards (CAS). Operating profit of the business segments excludes the FAS/CAS operating adjustment; the U.S. GAAP financial accounting standards (FAS) non-service cost component for all postretirement benefit plans; 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 2 – Significant Accounting Policy Updates” for a discussion related to certain factors that may impact the comparability of net sales and operating profit of our business segments.

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Notes to Consolidated Financial Statements (unaudited) (continued)

Summary operating results for each of our business segments were as follows (in millions):



	Quarters Ended						Six Months Ended
	June 24, 2018			June 25, 2017			June 24, 2018			June 25, 2017
Net sales
Aeronautics	$	5,321		$	4,922		$	9,719		$	9,042
Missiles and Fire Control	2,085			1,784			3,762			3,333
Rotary and Mission Systems	3,566			3,414			6,789			6,541
Space	2,426			2,443			4,763			4,859
Total net sales	$	13,398		$	12,563		$	25,033		$	23,775
Operating profit
Aeronautics	$	572		$	567		$	1,046		$	1,006
Missiles and Fire Control	279			253			540			487
Rotary and Mission Systems ^(a)	341			271			652			399
Space	274			256			538			546
Total business segment operating profit	1,466			1,347			2,776			2,438
Unallocated items
FAS/CAS operating adjustment ^(b)	451			404			902			807
Stock-based compensation	(60		)	(57		)	(98		)	(101		)
Severance and restructuring charges ^(c)	(96		)	—			(96		)	—
Other, net ^(d)	34			22			36			(26		)
Total unallocated items	329			369			744			680
Total consolidated operating profit	$	1,795		$	1,716		$	3,520		$	3,118
Intersegment sales
Aeronautics	$	27		$	40		$	52		$	65
Missiles and Fire Control	113			66			208			139
Rotary and Mission Systems	504			548			965			993
Space	48			19			93			45
Total intersegment sales	$	692		$	673		$	1,318		$	1,242


^(a)	Operating profit at our RMS business segment for the six months ended June 25, 2017 includes a charge of $120 million ($74 million, or $0.25 per share, after tax) recognized in the first quarter of 2017 for performance matters on the EADGE-T contract. See “Note 2 – Significant Accounting Policy Updates” (under the caption “Revenue Recognition”) for more information.


^(b)	The FAS/CAS operating adjustment represents the difference between the service cost component of FAS pension expense and total pension costs recoverable on U.S. Government contracts as determined in accordance with U.S. Government CAS. For a detail of the FAS/CAS operating adjustment and the total net FAS/CAS pension adjustment, see the table below.

^(c)

Unallocated items for the quarter and six months ended June 24, 2018 include severance and restructuring charges totaling $96 million ($76 million, or $0.26 per share, after tax) associated with planned workforce reductions and the consolidation of certain operations at our RMS business segment. See “Note 11 – Other” (under the caption “Severance and Restructuring Charges”) for more information.

^(d)

Other, net for the six months ended June 25, 2017 includes a $64 million charge ($40 million, or $0.14 per share, after tax) recognized in the first quarter of 2017, which represents our portion of a non-cash asset impairment charge recorded by our equity method investee, Advanced Military Maintenance, Repair and Overhaul Center LLC (AMMROC). See “Note 11 – Other” (under the caption “Equity Method Investee Impairment”) for more information.

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Lockheed Martin Corporation

Notes to Consolidated Financial Statements (unaudited) (continued)

Our total net FAS/CAS pension adjustments for the quarters and six months ended June 24, 2018 and June 25, 2017, including the service and non-service cost components of FAS pension expense, were as follows (in millions):



	Quarters Ended						Six Months Ended
	June 24, 2018			June 25, 2017			June 24, 2018			June 25, 2017
Total FAS expense and CAS costs
FAS pension expense	$	(357	)	$	(343	)	$	(713	)	$	(688	)
Less: CAS pension cost	609			562			1,217			1,124
Net FAS/CAS pension adjustment	$	252		$	219		$	504		$	436

Service and non-service cost reconciliation
FAS pension service cost	$	(158	)	$	(158	)	$	(315	)	$	(317	)
Less: CAS pension cost	609			562			1,217			1,124
FAS/CAS operating adjustment	451			404			902			807
Non-operating FAS pension expense	(199		)	(185		)	(398		)	(371		)
Net FAS/CAS pension adjustment	$	252		$	219		$	504		$	436

We recover CAS pension cost through the pricing of our products and services on U.S. Government contracts and, therefore, recognize CAS pension cost in each of our business segment’s net sales and cost of sales. Our consolidated financial statements must present FAS pension and other postretirement benefit plan expense calculated in accordance with FAS requirements under U.S. GAAP. The operating portion of the net FAS/CAS pension adjustment represents the difference between the service cost component of FAS pension expense and CAS pension cost. The non-service FAS pension cost component is included in other non-operating expense, net on our consolidated statements of earnings. The net FAS/CAS pension adjustment increases or decreases CAS pension cost to equal total FAS pension cost (both service and non-service).

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Lockheed Martin Corporation

Notes to Consolidated Financial Statements (unaudited) (continued)

Net sales by total products and services, contract type, customer category and geographic region for each of our business segments were as follows (in millions):



	Quarter Ended June 24, 2018
	Aeronautics		MFC		RMS		Space			Total
Net sales
Products	$	4,511	$	1,709	$	2,904	$	2,026		$	11,150
Services	810		376		662		400			2,248
Total net sales	$	5,321	$	2,085	$	3,566	$	2,426		$	13,398
Net sales by contract type
Fixed-price	$	3,906	$	1,395	$	2,450	$	460		$	8,211
Cost-reimbursable	1,415		690		1,116		1,966			5,187
Total net sales	$	5,321	$	2,085	$	3,566	$	2,426		$	13,398
Net sales by customer
U.S. Government	$	3,444	$	1,502	$	2,608	$	2,070		$	9,624
International ^(a)	1,835		542		822		344			3,543
U.S. commercial and other	42		41		136		12			231
Total net sales	$	5,321	$	2,085	$	3,566	$	2,426		$	13,398
Net sales by geographic region
United States	$	3,486	$	1,543	$	2,744	$	2,082		$	9,855
Asia Pacific	786		125		301		31			1,243
Europe	678		46		224		332			1,280
Middle East	320		364		143		(19		)	808
Other	51		7		154		—			212
Total net sales	$	5,321	$	2,085	$	3,566	$	2,426		$	13,398

	Six Months Ended June 24, 2018
	Aeronautics		MFC		RMS		Space			Total
Net sales
Products	$	8,281	$	3,062	$	5,621	$	3,948		$	20,912
Services	1,438		700		1,168		815			4,121
Total net sales	$	9,719	$	3,762	$	6,789	$	4,763		$	25,033
Net sales by contract type
Fixed-price	$	7,121	$	2,507	$	4,658	$	860		$	15,146
Cost-reimbursable	2,598		1,255		2,131		3,903			9,887
Total net sales	$	9,719	$	3,762	$	6,789	$	4,763		$	25,033
Net sales by customer
U.S. Government	$	6,209	$	2,590	$	4,964	$	3,940		$	17,703
International ^(a)	3,412		1,096		1,603		800			6,911
U.S. commercial and other	98		76		222		23			419
Total net sales	$	9,719	$	3,762	$	6,789	$	4,763		$	25,033
Net sales by geographic region
United States	$	6,307	$	2,666	$	5,186	$	3,963		$	18,122
Asia Pacific	1,540		223		625		54			2,442
Europe	1,186		115		379		758			2,438
Middle East	577		744		314		(12		)	1,623
Other	109		14		285		—			408
Total net sales	$	9,719	$	3,762	$	6,789	$	4,763		$	25,033


^(a)	International sales include FMS contracted through the U.S. Government and direct commercial sales to international governments and other international customers.

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Notes to Consolidated Financial Statements (unaudited) (continued)



	Quarter Ended June 25, 2017
	Aeronautics		MFC		RMS		Space		Total
Net sales
Products	$	4,206	$	1,452	$	2,863	$	2,101	$	10,622
Services	716		332		551		342		1,941
Total net sales	$	4,922	$	1,784	$	3,414	$	2,443	$	12,563
Net sales by contract type
Fixed-price	$	3,312	$	1,258	$	2,492	$	592	$	7,654
Cost-reimbursable	1,610		526		922		1,851		4,909
Total net sales	$	4,922	$	1,784	$	3,414	$	2,443	$	12,563
Net sales by customer
U.S. Government	$	3,233	$	1,059	$	2,379	$	2,105	$	8,776
International ^(a)	1,655		687		929		325		3,596
U.S. commercial and other	34		38		106		13		191
Total net sales	$	4,922	$	1,784	$	3,414	$	2,443	$	12,563
Net sales by geographic region
United States	$	3,267	$	1,097	$	2,485	$	2,118	$	8,967
Asia Pacific	694		114		343		36		1,187
Europe	599		82		245		288		1,214
Middle East	300		482		126		1		909
Other	62		9		215		—		286
Total net sales	$	4,922	$	1,784	$	3,414	$	2,443	$	12,563

	Six Months Ended June 25, 2017
	Aeronautics		MFC		RMS		Space		Total
Net sales
Products	$	7,840	$	2,709	$	5,511	$	4,175	$	20,235
Services	1,202		624		1,030		684		3,540
Total net sales	$	9,042	$	3,333	$	6,541	$	4,859	$	23,775
Net sales by contract type
Fixed-price	$	6,228	$	2,343	$	4,728	$	1,102	$	14,401
Cost-reimbursable	2,814		990		1,813		3,757		9,374
Total net sales	$	9,042	$	3,333	$	6,541	$	4,859	$	23,775
Net sales by customer
U.S. Government	$	5,916	$	2,136	$	4,674	$	4,117	$	16,843
International ^(a)	3,058		1,132		1,700		715		6,605
U.S. commercial and other	68		65		167		27		327
Total net sales	$	9,042	$	3,333	$	6,541	$	4,859	$	23,775
Net sales by geographic region
United States	$	5,984	$	2,201	$	4,841	$	4,144	$	17,170
Asia Pacific	1,225		206		617		40		2,088
Europe	1,102		157		447		622		2,328
Middle East	635		752		236		53		1,676
Other	96		17		400		—		513
Total net sales	$	9,042	$	3,333	$	6,541	$	4,859	$	23,775


^(a)	International sales include FMS contracted through the U.S. Government and direct commercial sales to international governments and other international customers.

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Notes to Consolidated Financial Statements (unaudited) (continued)

Total assets for each of our business segments were as follows (in millions):



	June 24, 2018		December 31, 2017
Assets
Aeronautics	$	8,283	$	7,713
Missiles and Fire Control	4,812		4,577
Rotary and Mission Systems	18,495		18,292
Space	5,502		5,240
Total business segment assets	37,092		35,822
Corporate assets ^(a)	8,033		10,798
Total assets	$	45,125	$	46,620


^(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 27% and 26% of our total consolidated net sales for the quarter and six months ended June 24, 2018 and 26% and 25% of our total consolidated net sales for the quarter and six months ended June 25, 2017.

NOTE 5 – CONTRACT ASSETS AND LIABILITIES

Contract assets include unbilled amounts typically resulting from sales under contracts when the percentage-of-completion cost-to-cost method of revenue recognition is utilized and revenue recognized exceeds the amount billed to the customer. Contract liabilities (formerly referred to as customer advances and amounts in excess of costs incurred) include advance payments and billings in excess of revenue recognized. Contract assets and contract liabilities were as follows (in millions):



	June 24, 2018		December 31, 2017
Contract assets	$	9,281	$	7,992
Contract liabilities	$	6,413	$	7,028

Contract assets increased $1.3 billion during the six months ended June 24, 2018, primarily due to the recognition of revenue related to the satisfaction or partial satisfaction of performance obligations during the six months ended June 24, 2018 for which we have not yet billed. There were no significant impairment losses related to our contract assets during the quarters and six months ended June 24, 2018 and June 25, 2017.

Contract liabilities decreased $615 million during the six months ended June 24, 2018, primarily due to revenue recognized in excess of payments received on these performance obligations. During the quarter and six months ended June 24, 2018, we recognized $731 million and $2.6 billion of our contract liabilities at December 31, 2017 as revenue. During the quarter and six months ended June 25, 2017, we recognized $789 million and $2.4 billion of our contract liabilities at December 31, 2016 as revenue.

NOTE 6 – INVENTORIES

Inventories consisted of the following (in millions):



	June 24, 2018		December 31, 2017
Materials, spares and supplies	$	446	$	563
Work-in-process	2,074		1,823
Finished goods	518		492
Total inventories	$	3,038