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LOCKHEED MARTIN CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.
[October 24, 2014]

LOCKHEED MARTIN CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.


(Edgar Glimpses Via Acquire Media NewsEdge) 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, logistic, and information services. We serve both domestic 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 2013, 82% of our $45.4 billion in net sales were from the U.S. Government, either as a prime contractor or as a subcontractor (including 61% from the Department of Defense (DoD)), 17% were from international customers (including foreign military sales (FMS) contracted through the U.S. Government), and 1% were from U.S. commercial and other customers. Our main areas of focus are in defense, space, intelligence, homeland security, and information technology, including cyber security.

We expect 2015 net sales will decline at a low single digit rate from 2014 levels and that total business segment operating margin will be in the 11.5% to 12.0% range. Our preliminary outlook for 2015 assumes the U.S. Government continues to support and fund our key programs, consistent with the continuing resolution funding measure through December 2014, and the U.S. Government approves budget legislation for government fiscal year (GFY) 2015 consistent with the President's proposed budget. Changes in circumstances may require us to revise our assumptions, which could materially change our current estimate of 2015 net sales and operating margin.

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, 2013 (2013 Form 10-K).

INDUSTRY CONSIDERATIONS U.S. Government Funding Constraints The U.S. Government, our principal customer, continues to face significant fiscal and economic challenges. To address those challenges, the U.S. Government has implemented various initiatives, including measures to reduce its spending levels pursuant to the Budget Control Act of 2011 (Budget Control Act). The Budget Control Act established limits on discretionary spending, which provided for reductions to planned defense spending by $487 billion over a 10 year period that began with GFY 2012 (a U.S. Government fiscal year starts on October 1 and ends on September 30). The Budget Control Act also provided for additional automatic spending reductions, known as sequestration, which went into effect on March 1, 2013, that would have reduced planned defense spending by an additional $500 billion over a nine-year period that began in GFY 2013.

In December 2013, the U.S. Government enacted the Bipartisan Budget Act of 2013 (Bipartisan Budget Act), which increased the limits on discretionary spending for GFY 2015 among other fiscal changes. Although the Bipartisan Budget Act allows for more certainty in the budget planning process for GFY 2015, it retained sequestration cuts for GFYs 2016 through 2021, including the across-the-board spending reduction methodology provided for in the Budget Control Act. As a result, there remains uncertainty regarding how sequestration cuts beyond GFY 2015 will be applied as the DoD and other agencies may have significantly less flexibility in how to apply budget cuts in future years.

While the defense budget sustained the largest single reductions under the Budget Control Act, other civil agencies and programs have also been impacted by significant spending reductions. In light of the Budget Control Act and deficit reduction pressures, it is likely that discretionary spending by the U.S.

Government will remain constrained for a number of years.

In March 2014, the President's budget request for GFY 2015 was submitted to Congress, which supports the current national security strategy and is within the revised defense spending limit of $521 billion for GFY 2015 imposed by the Bipartisan Budget Act. However, Congress has not yet approved the GFY 2015 budget. In September 2014, the U.S. Government passed a continuing resolution funding measure to finance all U.S. Government activities through December 11, 2014. Under this continuing resolution, partial-year funding is available at prior year levels, subject to certain restrictions, but new spending initiatives are not authorized.

24 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) During periods covered by continuing resolutions (or until the regular appropriation bills are passed) we may experience delays in the procurement of our products and services and collection of payment due to lack of funding, and such delays may affect our results of operations, financial position, and cash flows.

We anticipate there will continue to be a significant debate within the U.S.

Government over defense spending throughout the budget process for GFY 2015 and beyond. The outcome of these debates could have long-term consequences for our industry and company as described below. 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.

Potential Impacts of Budget Reductions While recent budget actions such as the Bipartisan Budget Act provide a more measured and strategic approach to addressing the U.S. Government's fiscal challenges, sequestration remains a long-term concern. If not further modified, sequestration could have significant negative impacts on our industry and company in future periods. There may be disruption of ongoing programs, impacts to our supply chain, contractual actions (including partial or complete terminations), potential facilities closures, and thousands of personnel reductions across the industry that will severely impact advanced manufacturing operations and engineering expertise, and accelerate the loss of skills and knowledge. Sequestration, or other budgetary cuts in lieu of sequestration, could have a material negative effect on our company.

Despite the continued uncertainty surrounding U.S. Government budgets, 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. Additionally, we are seeking to lessen our dependence on contracts with the U.S. Government by focusing on expanding into adjacent markets close to our core capabilities and growing international sales. The possibility remains, however, 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, or budget reductions, including sequestration (particularly in those circumstances where sequestration is implemented across-the-board without regard to national priorities). Additionally, decreases in production volume associated with budget cuts, including sequestration, will increase unit costs making our products less affordable for both our domestic and international customers. In particular, sequestration may also result in significant rescheduling or termination activity with our supplier base. Such activity could result in claims from our suppliers, which may include the amount established in any settlement agreements, the costs of evaluating the supplier settlement proposals, and the costs of negotiating settlement agreements. Budget cuts, including sequestration, could result in restructuring charges, impairment of assets, including goodwill, or other charges. We expect costs associated with claims from our suppliers and restructuring charges will be recovered from our customers.

Generally, we expect that the impact of budget reductions on our operating results will lag in certain of our businesses with longer cycles such as our Aeronautics and Space Systems business segments, and our products businesses within our Missiles and Fire Control (MFC) and Mission Systems and Training (MST) business segments, due to our production contract backlog. However, our businesses with smaller, short-term contracts are the most susceptible to the impacts of budget reductions, such as our Information Systems & Global Solutions (IS&GS) business segment and certain services businesses within our MFC and MST business segments. We have also experienced increased market pressures in these services businesses including lower in-theater support as troop levels are drawn down and increased re-competition coupled with the fragmentation of large contracts into multiple smaller contracts that are awarded primarily on the basis of price. Additionally, our service businesses across all of our business segments have experienced lower volume due to improved product field performance that require less service support.

25 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) CONSOLIDATED RESULTS OF OPERATIONS Since our operating cycle is 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 28, September 29, September 28, September 29, 2014 2013 2014 2013 Net sales $ 11,114 $ 11,347 $ 33,070 $ 33,825 Cost of sales (9,839) (10,163) (29,083) (30,376) Gross profit 1,275 1,184 3,987 3,449 Other income, net 117 70 263 222 Operating profit 1,392 1,254 4,250 3,671 Interest expense (82) (84) (253) (264) Other non-operating income, net 1 3 3 2 Earnings from continuing operations before income taxes 1,311 1,173 4,000 3,409 Income tax expense (423) (331) (1,290) (947) Net earnings from continuing operations 888 842 2,710 2,462 Net earnings from discontinued operations - 31 - 31 Net earnings 888 873 2,710 2,493 Diluted earnings per common share Continuing operations 2.76 2.57 8.39 7.54 Discontinued operations - .09 - .09 Total diluted earnings per common share $ 2.76 $ 2.66 $ 8.39 $ 7.63 Certain amounts reported in other income, net, primarily our share of earnings or losses from equity method investees, are included in the operating profit of our business segments. Accordingly, such amounts are included in the description of our business segment results of operations.

Net Sales We generate sales from the delivery of products and services. Products sales are predominantly generated in our Aeronautics, MFC, MST, and Space Systems business segments, and most of our services sales are generated in our IS&GS and MFC business segments. Our consolidated net sales were as follows (in millions): Quarters Ended Nine Months Ended September 28, September 29, September 28, September 29, 2014 2013 2014 2013 Products $ 8,602 $ 8,859 $ 25,992 $ 26,570 Services 2,512 2,488 7,078 7,255 Total net sales $ 11,114 $ 11,347 $ 33,070 $ 33,825 Substantially all of our contracts are accounted for using the percentage-of-completion method of accounting. Under the percentage-of-completion method, we record net sales on contracts based upon our progress towards completion on a particular contract, as well as our estimate of the profit to be earned at completion. The following discussion of material changes in our consolidated net sales should be read in tandem with the following discussion of changes in our consolidated cost of sales and our business segment results of operations because changes in our sales are typically accompanied by a corresponding change in our cost of sales due to the nature of percentage-of-completion accounting.

26 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Products Sales Our products sales represent about 80% of our net sales for both the quarters ended September 28, 2014 and September 29, 2013. Products sales decreased $257 million, or 3%, during the quarter ended September 28, 2014, compared to the quarter ended September 29, 2013, primarily due to lower products sales of about $110 million at IS&GS, about $80 million at Space Systems, and about $30 million at both MFC and Aeronautics. The decrease at IS&GS was primarily driven by the wind-down or completion of certain programs (primarily command and control programs) and lower volume for various other programs. The decrease at Space Systems was primarily due to lower volume for government satellite programs (primarily Advanced Extremely High Frequency (AEHF)). The decline at MFC was primarily attributable to tactical missile programs due to fewer missile and launcher deliveries (including the Guided Multiple Launcher Rocket Systems (GMLRS)). The decrease at Aeronautics was primarily attributable to fewer aircraft deliveries for the C-130 program, partially offset by increased volume on the F-35 production contracts and increased deliveries on the F-16 program.

Our products sales represent about 80% of our net sales for both the nine months ended September 28, 2014 and September 29, 2013. Products sales decreased $578 million, or 2%, during the nine months ended September 28, 2014, compared to the nine months ended September 29, 2013. Lower products sales of about $455 million at IS&GS, about $410 million at Space Systems, about $235 million at MST, and about $90 million at MFC were partially offset by increased products sales of about $610 million at Aeronautics. The decrease at IS&GS was primarily driven by the wind-down or completion of certain programs (primarily command and control programs) and lower volume for various other programs. The decline at Space Systems was due to lower volume for government satellite programs (primarily AEHF, Mobile User Objective System (MUOS), and Global Positioning System III (GPS-III)). The decrease at MST was attributable to decreased volume for undersea systems programs, various integrated warfare systems and sensors programs (primarily electronic warfare, radar surveillance programs and Aegis) and settlements of contract cost matters on certain programs in the prior year (including a portion of the terminated presidential helicopter program) that were not repeated in 2014. The decline at MFC was primarily attributable to tactical missiles programs due to fewer missile and launcher deliveries (including GMLRS). Higher products sales at Aeronautics were attributable to increased volume on F-35production contracts and increased aircraft deliveries (C-5 and F-16 programs).

Services Sales Our services sales represent about 20% of our net sales for both the quarters and nine months ended September 28, 2014 and September 29, 2013. Services sales increased $24 million, or 1%, during the quarter ended September 28, 2014, compared to the quarter ended September 29, 2013. Higher services sales of about $160 million at Space Systems for commercial space transportation programs due to launch-related activities were partially offset by lower services sales of approximately $65 million at MFC, primarily attributable to lower volume for various technical services programs due to lower volume reflecting market pressures, and about $60 million at Aeronautics, mostly related to a decrease in sustainment activities.

Services sales decreased $177 million, or 2%, during the nine months ended September 28, 2014, compared to the nine months ended September 29, 2013. The decreases were primarily due to lower services sales at MFC of about $280 million primarily attributable to lower volume for various technical services due to lower volume reflecting market pressures, and lower services sales at Aeronautics of about $50 million attributable to decreased sustainment activities. These decreases were partially offset by higher services sales at Space Systems of about $150 million for commercial space transportation programs due to launch-related activities.

Cost of Sales Cost of sales, for both products and services, consist of materials, labor, subcontracting costs, an allocation of indirect costs (overhead and general and administrative), as well as the costs to fulfill our industrial cooperation agreements, sometimes referred to as offset agreements, required under certain contracts with international 27 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) customers. For each of our contracts, we monitor the nature and amount of costs at the contract level, which form the basis for estimating our total costs to complete the contract. Our consolidated cost of sales were as follows (in millions): Quarters Ended Nine Months Ended September 28, September 29, September 28, September 29, 2014 2013 2014 2013 Cost of products sales $ (7,659) $ (7,759) $ (22,928) $ (23,245) % of products sales 89.0% 87.6% 88.2% 87.5% Cost of services sales (2,228) (2,202) (6,241) (6,473) % of services sales 88.7% 88.5% 88.2% 89.2% Severance charges - - - (30) Other unallocated, net 48 (202) 86 (628) Total cost of sales $ (9,839) $ (10,163) $ (29,083) $ (30,376) Due to the nature of percentage-of-completion accounting, changes in our cost of sales for both products and services are typically accompanied by changes in our net sales. The following discussion of material changes in our consolidated cost of sales for products and services should be read in tandem with the preceding discussion of changes in our consolidated net sales and our business segment results of operations. We have not identified any developing trends in cost of sales for products and services that would have a material impact on our future operations.

Cost of Products Sales Cost of products sales decreased $100 million, or 1%, during the quarter ended September 28, 2014, compared to the quarter ended September 29, 2013. Lower cost of products sales of about $80 million at IS&GS and about $45 million at Space Systems were partially offset by higher cost of products sales of about $35 million at Aeronautics. The decreases in cost of products sales at IS&GS and Space Systems were attributable to lower volume for various programs as mentioned in the products sales summary above. The increase at Aeronautics was primarily attributable to increased volume on F-35 production contracts and increased deliveries and decreased risk retirements on the F-16 program. The 1.4% increase in the percentage of cost of products sales relative to products sales for the quarter ended September 28, 2014 compared to the quarter ended September 29, 2013 was primarily due to reserves recorded for contractual matters, and the decrease of risk retirements on the F-16 program at Aeronautics and decrease in risk retirements for government satellite programs (primarily AEHF) at Space Systems.

Cost of products sales decreased $317 million, or 1%, during the nine months ended September 28, 2014, compared to the nine months ended September 29, 2013.

Lower cost of products sales of about $375 million at IS&GS, about $355 million at Space Systems, about $145 million at MST, and about $60 million at MFC were partially offset by higher cost of products sales of about $615 million at Aeronautics. The decreases at IS&GS, Space Systems, MST, and MFC were attributable to lower volume and fewer deliveries for various programs as mentioned in the products sales summary above. The increase in cost of products sales at Aeronautics was primarily attributable to increased volume on F-35 production contracts and increased aircraft deliveries (C-5 and F-16 programs) and lower risk retirements (primarily the F-16 program). The 0.7% increase in the percentage of cost of products sales relative to products sales for the nine months ended September 28, 2014 compared to the nine months ended September 29, 2013 was primarily attributable to Aeronautics due to lower risk retirements (primarily the F-16 program), MST due to the settlements of contract cost matters on certain programs in the prior year (including a portion of the terminated presidential helicopter program) that were not repeated in 2014 and reserves recorded on certain training and logistics solutions programs during the nine months ended September 28, 2014 and MFC due to net warranty reserve adjustments (including Joint Air-to-Surface Standoff Missile (JASSM), and GMLRS) during the nine months ended September 28, 2014.

28 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Cost of Services Sales Cost of services sales increased $26 million, or 1%, during the quarter ended September 28, 2014 compared to the quarter ended September 29, 2013. Higher cost of services sales of about $145 million at Space Systems for commercial space transportation programs due to launch-related activities were partially offset by about $70 million at MFC, primarily attributable to lower volume for various technical services programs, and about $45 million at Aeronautics, mostly related to a decrease in sustainment activities.

Cost of services sales decreased $232 million, or 4%, during the nine months ended September 28, 2014, compared to the nine months ended September 29, 2013.

Lower costs of services sales of about $265 million at MFC, about $55 million at Aeronautics, and about $35 million at IS&GS were partially offset by an increase in cost of service sales of about $135 million at Space Systems. The decrease at MFC was attributable to lower volume for various technical services programs.

The decline at Aeronautics was mostly attributable to decreased sustainment activities. The decrease at IS&GS was primarily driven by the wind-down or completion of certain programs (primarily command and control programs) and lower volume for various other programs. The increase at Space Systems was primarily attributable to commercial space transportation programs due to launch-related activities. The 1.0% decrease in the percentage of cost of services sales relative to services sales for the nine months ended September 28, 2014 compared to the nine months ended September 29, 2013 was primarily due to the items decreasing cost of services sales at IS&GS and MFC.

Restructuring Charges Fourth Quarter 2013 Action In November 2013, we committed to a plan to close and consolidate certain facilities and reduce our total workforce by approximately 4,000 positions within our IS&GS, MST, and Space Systems business segments. This plan resulted from a strategic review of our facilities capacity and future workload projections and is intended to better align our organization and cost structure and improve the affordability of our products and services given the changes in U.S. Government spending as well as the rapidly changing competitive and economic landscape.

We expect to incur total accelerated costs (e.g., accelerated depreciation expense related to long-lived assets at the sites to be closed) and incremental costs (e.g., relocation of equipment and other employee related costs) of approximately $15 million, $50 million, and $175 million at our IS&GS, MST, and Space Systems business segments through the completion of this plan in 2015. As of September 28, 2014, we have incurred total accelerated and incremental costs of approximately $78 million, inclusive of amounts incurred during the nine months ended September 28, 2014. The accelerated and incremental costs are recorded as incurred in cost of sales on our Statements of Earnings and included in the respective business segment's results of operations.

During the quarter ended December 31, 2013, we incurred severance charges related to this action of $171 million, net of state tax benefits, of which $53 million, $37 million, and $81 million related to our IS&GS, MST, and Space Systems business segments. Upon separation, terminated employees receive lump-sum severance payments primarily based on years of service. As of September 28, 2014, we have paid approximately $95 million in severance payments associated with this action, of which approximately $80 million was paid during the nine months ended September 28, 2014. The remaining severance payments are expected to be paid through the middle of 2015.

We expect to recover a substantial amount of the restructuring charges through the pricing of our products and services to the U.S. Government and other customers, with the impact included in the respective business segment's results of operations.

First Quarter 2013 Action During the quarter ended March 31, 2013, we recorded severance charges totaling $30 million, net of state tax benefits, related to our IS&GS business segment, which reduced our net earnings by $19 million ($.06 per share). These severance actions resulted from a strategic review of this business segment to better align our cost structure with changing economic conditions and also reflect changes in program lifecycles. The charges consisted of severance costs 29 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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, all of which were paid in 2013.

Other Unallocated, Net Other unallocated, net primarily includes the FAS/CAS pension adjustment as described in the Business Segment Results of Operations section below, stock-based compensation, and other corporate costs. These items are not allocated to the business segments and, therefore, are excluded from costs of sales for products and services. Other unallocated, net was $48 million and $86 million of income for the quarter and nine months ended September 28, 2014, compared to $202 million and $628 million of expense for the quarter and nine months ended September 29, 2013.

The fluctuation between each respective period was primarily attributable to the change in the FAS/CAS pension adjustment to income of $84 million and $255 million for the quarter and nine months ended September 28, 2014 compared to expense of $121 million and $362 million for the quarter and nine months ended September 29, 2013. The changes in the FAS/CAS pension adjustment between the periods were attributable to various items impacting the calculations of financial accounting standards (FAS) pension expense and U.S. Government Cost Accounting Standards (CAS) pension cost. FAS pension expense for the quarter and nine months ended September 28, 2014 was less than in the quarter and nine months ended September 29, 2013 due to higher discount rates used to calculate our qualified defined benefit obligations and net periodic benefit cost.

Additionally, the June 2014 plan amendments to certain of our defined benefit pension plans reduced FAS pension expense beginning in the quarter ended September 28, 2014 (Note 5, under the caption "Plan Amendments and Re-measurements"). CAS pension cost in the quarter ended September 28, 2014 was less than in the quarter ended September 29, 2013 due to the effect of using a higher interest rate required by the Highway and Transportation Funding Act of 2014 (HATFA), which was enacted on August 8, 2014. The higher CAS pension cost during the nine months ended September 28, 2014 reflects the impact of phasing in CAS Harmonization, partially offset by the effect of higher interest rates required by the HATFA. The effect of adopting the HATFA reduced our CAS pension cost by $55 million (including $35 million related to the first six months of 2014) in the quarter and nine months ended September 28, 2014. See "Critical Accounting Policies - Postretirement Benefit Plans" for a discussion of HATFA and CAS Harmonization and the impact on our CAS pension cost.

Other Income, Net Other income, net primarily includes our share of earnings or losses from equity method investees. For the quarter and nine months ended September 28, 2014, other income, net was $117 million and $263 million, compared to $70 million and $222 million for the quarter and nine months ended September 29, 2013. The changes were primarily attributable to fluctuations in our share of earnings from equity method investees, as discussed in the "Business Segment Results of Operations" section under the caption "Space Systems." Interest Expense Interest expense for the quarter and nine months ended September 28, 2014 was $82 million and $253 million, about the same for the respective prior periods.

Other Non-Operating Income, Net Other non-operating income, net for the quarter and nine months ended September 28, 2014 was comparable to the respective prior periods.

30 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Income Tax Expense Our effective income tax rates were 32.3% for both the quarter and nine months ended September 28, 2014 and 28.2% and 27.8% for the quarter and nine months ended September 29, 2013. The rates for all periods benefited from tax deductions for U.S. manufacturing activities and for dividends paid to our defined contribution plans with an employee stock ownership plan feature. The effective tax rates for the quarter and nine months ended September 28, 2014 were higher, primarily due to the benefit of research and development tax credits recognized in the quarter and nine months ended September 29, 2013. The credit expired on December 31, 2013 and, therefore, will not be recognized in 2014 unless and until legislation is enacted. The effective tax rate for the nine months ended September 28, 2014 was also higher due to tax reserve adjustments recorded in the quarter ended June 29, 2014.

Future changes in tax law could significantly impact our provision for income taxes, the amount of taxes payable, and our deferred tax asset and liability balances. Recent proposals to lower the U.S. corporate income tax rate would require us to reduce our net deferred tax assets upon enactment of new tax legislation, with a corresponding material, one-time, non-cash increase in income tax expense, but our income tax expense and payments would be materially reduced in subsequent years. Our net deferred tax assets as of September 28, 2014 and December 31, 2013 were $4.1 billion and $3.9 billion, based on a 35% Federal statutory income tax rate, and primarily relate to our postretirement benefit plans. If legislation reducing the Federal statutory income tax rate to 25% had been enacted at September 28, 2014, our net deferred tax assets would have been reduced by $1.2 billion, and we would have recorded a corresponding one-time, non-cash increase in income tax expense of $1.2 billion. This additional expense would be less if the legislation phased in the tax rate reduction or if the final rate was higher than 25%. The amount of net deferred tax assets will change periodically based on several factors, including the measurement of our postretirement benefit plan obligations and actual cash contributions to our postretirement benefit plans.

Net Earnings from Continuing Operations Net earnings from continuing operations for the quarter and nine months ended September 28, 2014 were $888 million ($2.76 per share) and $2.7 billion ($8.39 per share), compared to $842 million ($2.57 per share) and $2.5 billion ($7.54 per share) for the quarter and nine months ended September 29, 2013. Both net earnings and earnings per share were affected by the factors mentioned above.

Earnings per share also benefited from a net decrease of approximately four million common shares outstanding from September 29, 2013 to September 28, 2014 as a result of share repurchases, which were partially offset by share issuances under our stock-based awards and certain defined contribution plans.

Net Earnings from Discontinued Operations Net earnings from discontinued operations for the quarter and nine months ended September 29, 2013 include a benefit of $31 million resulting from the resolution of certain tax matters related to a business sold prior to 2013.

BUSINESS SEGMENT RESULTS OF OPERATIONS We operate in five business segments: Aeronautics, IS&GS, MFC, MST, and Space Systems. 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. Intercompany transactions are generally negotiated under terms and conditions that share many similar characteristics (e.g., contract structures, funding profiles, target cost values, and contract progress reports) with our third-party contracts, primarily with the U.S. Government.

Operating profit of our business segments includes our share of earnings or losses from equity method investees because the operating activities of the equity method investees are closely aligned with the operations of our business segments. United Launch Alliance (ULA), which is part of our Space Systems business segment, is our primary equity 31 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) 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 (Note 8, under the caption "Restructuring Charges") and goodwill impairments; gains or losses from 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, net" between operating profit from our business segments and our consolidated operating profit.

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 FAS requirements under U.S. generally accepted accounting principles (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. As a result, to the extent that CAS pension cost exceeds FAS pension expense, which occurred for the quarter and nine months ended September 28, 2014, we have FAS/CAS pension income and, conversely, to the extent FAS pension expense exceeds CAS pension cost, which occurred for the quarter and nine months ended September 29, 2013, we have FAS/CAS pension expense.

32 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Summary operating results for each of our business segments were as follows (in millions): Quarters Ended Nine Months Ended September 28, September 29, September 28, September 29, 2014 2013 2014 2013 Net sales Aeronautics $ 3,544 $ 3,632 $ 10,785 $ 10,225 Information Systems & Global Solutions 1,949 2,059 5,800 6,266 Missiles and Fire Control 1,908 2,003 5,666 6,034 Mission Systems and Training 1,679 1,698 5,078 5,298 Space Systems 2,034 1,955 5,741 6,002 Total net sales $ 11,114 $ 11,347 $ 33,070 $ 33,825 Operating profit Aeronautics $ 362 $ 412 $ 1,208 $ 1,198 Information Systems & Global Solutions 175 187 524 570 Missiles and Fire Control 335 356 1,038 1,081 Mission Systems and Training 193 216 628 692 Space Systems 281 284 783 790 Total business segment operating profit 1,346 1,455 4,181 4,331 Unallocated, net FAS/CAS pension adjustment FAS pension expense (a) (258) (487) (885) (1,461) Less: CAS pension cost (b) 342 366 1,140 1,099 FAS/CAS pension income (expense) 84 (121) 255 (362) Severance charges (c) - - - (30) Stock-based compensation (31) (38) (128) (150) Other, net (7) (42) (58) (118) Total unallocated, net 46 (201) 69 (660) Total consolidated operating profit $ 1,392 $ 1,254 $ 4,250 $ 3,671 (a) FAS pension expense for the quarter and nine months ended September 28, 2014 was less than in the quarter and nine months ended September 29, 2013 due to higher discount rates used to calculate our qualified defined benefit obligations and net periodic benefit cost. Additionally, the June 2014 plan amendments to certain of our defined benefit pension plans to freeze future retirement benefits reduced FAS pension expense beginning in the quarter ended September 28, 2014 (Note 5, under the caption "Plan Amendments and Re-measurements").

(b) CAS pension cost for the quarter ended September 28, 2014 was less than in the quarter ended September 29, 2013 due to the effect of using a higher interest rate required by the HATFA, which was enacted on August 8, 2014.

The higher CAS pension cost during the nine months ended September 28, 2014 reflects the impact of phasing in CAS Harmonization, partially offset by the effect of higher interest rates required by the HATFA. The effect of adopting the HATFA reduced our CAS pension cost by $55 million (including $35 million related to the first six months of 2014) in the quarter and nine months ended September 28, 2014. See "Critical Accounting Policies - Postretirement Benefit Plans" for a discussion of HATFA and CAS Harmonization and the impact on our CAS pension cost.

(c) Severance charges during the nine months ended September 29, 2013 consisted of amounts, net of state tax benefits, associated with the elimination of certain positions at our IS&GS business segment (Note 8, under the caption "Restructuring Charges"). Severance charges for initiatives that are not significant are included in business segment operating profit.

Management evaluates performance on our contracts by focusing on net sales and operating profit, and not by type or amount of operating expense. Consequently, our discussion of business segment performance focuses on net sales and operating profit, consistent with our approach for managing the business. This approach is consistent throughout the life cycle of our contracts, as management assesses the bidding of each contract by focusing on net sales and operating profit, and monitors performance on our contracts in a similar manner through their completion.

33 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) We regularly provide customers with reports of our costs as the contract progresses. The cost information in the reports is accumulated in a manner specified by the requirements of each contract. For example, cost data provided to a customer for a product would typically align to the subcomponents of that product (such as a wing-box on an aircraft), and for services would align to the type of work being performed (such as help-desk support). Our contracts generally are cost-based, which allows for the recovery of costs in the pricing of our products and services. Most of our contracts are bid and negotiated with our customers under circumstances in which we are required to disclose our estimated total costs to provide the product or service. This approach for negotiating contracts with our U.S. Government customers generally allows for the recovery of our costs. We also may enter into long-term supply contracts for certain materials or components to coincide with the production schedule of certain products and to ensure their availability at known unit prices.

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 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. 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. 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.

Changes in net sales and operating profit generally are expressed in terms of volume. Changes in volume refer to increases or decreases in sales or operating profit resulting from varying production activity levels, deliveries, or service levels on individual contracts. Volume changes in segment operating profit are typically based on the current profit booking rate for a particular contract.

In addition, comparability of our segment sales, operating profit and operating margins may be impacted 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 margins 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, and insurance recoveries. Unfavorable items may include the adverse resolution of contractual matters; restructuring charges, except for significant severance actions (Note 8, under the caption "Restructuring Charges") which are excluded from segment operating results; reserves for disputes; and significant asset impairments. Segment operating profit and items such as risk retirements, reductions of profit booking rates or other matters are presented net of state income taxes.

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 $400 million and $1.4 billion for the quarter and nine months ended September 28, 2014 and $510 million and $1.6 billion for the quarter and nine months ended September 29, 2013. The consolidated net adjustments for the nine months ended September 28, 2014 include reserves recorded on certain training and logistics solutions programs at MST and net warranty reserve adjustments for various programs (including JASSM and GMLRS) at MFC as mentioned in the respective business segment's results of operations. The consolidated net adjustments for the nine months ended September 29, 2013 include significant profit reductions on the F-35 development contract, and the C-5 program for the quarter and nine months ended September 29, 2013, as mentioned in our Aeronautics business segment's results of operations.

34 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Aeronautics Summary operating results for our Aeronautics business segment were as follows (in millions): Quarters Ended Nine Months Ended September 28, September 29, September 28, September 29, 2014 2013 2014 2013 Net sales $ 3,544 $ 3,632 $ 10,785 $ 10,225 Operating profit 362 412 1,208 1,198 Operating margins 10.2% 11.3% 11.2% 11.7% Aeronautics' net sales for the quarter ended September 28, 2014 decreased $88 million, or 2%, compared to the quarter ended September 29, 2013. The decrease was primarily attributable to lower net sales of approximately $225 million for the C-130 program due to fewer deliveries (five aircraft delivered in the quarter ended September 28, 2014 compared to eight delivered in the quarter ended September 29, 2013) and lower sustainment activities; about $80 million for the F-35 development contract due to lower volume; and approximately $30 million for other sustainment activities due to lower volume. The decreases were partially offset by higher net sales of approximately $130 million for F-35 production contracts due to increased volume, partially offset by lower risk retirements; and approximately $115 million for various other programs due to increased volume.

Aeronautics' operating profit for the quarter ended September 28, 2014 decreased $50 million, or 12%, compared to the quarter ended September 29, 2013. The decrease was primarily attributable to lower operating profit of approximately $50 million for the C-130 program due to lower risk retirements and fewer aircraft deliveries; about $40 million for other sustainment activities due to lower risk retirements and lower volume; and approximately $30 million due to reserves recorded for contractual matters. The decreases were partially offset by higher operating profit of about $35 million for the C-5 program due to the absence in the quarter ended September 28, 2014 of the downward revision in the profit booking rate that occurred in the quarter ended September 29, 2013; and approximately $40 million for various other programs and equity earnings from a joint venture. Operating profit was comparable for the F-35 development contract. Operating profit was comparable for F-35 production contracts due to increased volume offset by lower risk retirements. Adjustments not related to volume, including net profit booking rate adjustments and other matters, were approximately $65 million lower for the quarter ended September 28, 2014 compared to the quarter ended September 29, 2013.

Aeronautics' net sales for the nine months ended September 28, 2014 increased $560 million, or 5%, compared to the nine months ended September 29, 2013. The increase was primarily attributable to higher net sales of approximately $530 million for F-35 production contracts due to increased volume; about $220 million for the C-5 program due to increased aircraft deliveries (six aircraft delivered in the nine months ended September 28, 2014 compared to two delivered in the nine months ended September 29, 2013), partially offset by decreased support and spares activities; and approximately $50 million for the F-16 program due to increased aircraft deliveries (11 aircraft delivered in the nine months ended September 28, 2014 compared to nine delivered in the nine months ended September 29, 2013) and sustainment activities, partially offset by aircraft configuration mix. The increases were partially offset by lower net sales of approximately $240 million for the C-130 program due to fewer deliveries (16 aircraft delivered in the nine months ended September 28, 2014 compared to 19 delivered in the nine months ended September 29, 2013) and decreased sustainment activities, partially offset by delivered aircraft contract mix; and about $50 million for the F-35 development contract due to lower volume, partially offset by the absence of downward revisions to the profit booking rate for the nine months ended September 28, 2014.

Aeronautics' operating profit for the nine months ended September 28, 2014 was comparable to the nine months ended September 29, 2013. Operating profit increased by approximately $85 million for the F-35 development contract due to the absence in the nine months ended September 28, 2014 of the downward revision in the profit booking rate that occurred in the nine months ended September 29, 2013; about $35 million for the C-5 program due to the absence of downward revisions to the profit booking rate in the nine months ended September 28, 2014; approximately $20 million for F-35 production contracts due to increased volume, partially offset by lower risk retirements; and about $70 million for various other programs and equity earnings from a joint venture. The increases were offset by lower operating profit of about $105 million for the F-16 program due to lower risk retirements; approximately $60 million for other sustainment activities due to lower volume and risk retirements; and about $30 million due to reserves recorded for contractual matters. Adjustments not related to volume, including net profit booking rate adjustments and other matters, were approximately $80 million lower for the nine months ended September 28, 2014 compared to the nine months ended September 29, 2013.

35 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) We expect Aeronautics' net sales to increase in 2014 in the mid-single digit percentage range as compared to 2013, primarily due to an increase in net sales from F-35 production contracts. Operating profit is expected to increase slightly from that in 2013 but to a lesser extent than sales, resulting in a slight decrease in operating margins between the years due to program mix.

Information Systems & Global Solutions Summary operating results for our IS&GS business segment were as follows (in millions): Quarters Ended Nine Months Ended September 28, September 29, September 28, September 29, 2014 2013 2014 2013 Net sales $ 1,949 $ 2,059 $ 5,800 $ 6,266 Operating profit 175 187 524 570 Operating margins 9.0% 9.1% 9.0% 9.1% IS&GS' net sales decreased $110 million, or 5%, for the quarter ended September 28, 2014 and $466 million, or 7%, for the nine months ended September 28, 2014 compared to the quarter and nine months ended September 29, 2013. The decreases in both periods were primarily attributable to lower net sales of approximately $150 million for the quarter ended September 28, 2014 and about $525 million for the nine months ended September 28, 2014 due to the wind-down or completion of certain programs (primarily command and control programs); and about $60 million for the quarter ended September 28, 2014 and approximately $345 million for the nine months ended September 28, 2014 due to a decline in volume for various programs, which reflects lower funding levels and programs impacted by in-theater force reductions. The decreases were partially offset by higher net sales of about $100 million for the quarter ended September 28, 2014 and approximately $400 million for the nine months ended September 28, 2014 due to the start-up of new programs, growth in recently awarded programs and integration of recently acquired companies.

IS&GS' operating profit for the quarter ended September 28, 2014 decreased $12 million, or 6%, and $46 million, or 8%, for the nine months ended September 28, 2014 compared to the quarter and nine months ended September 29, 2013. The decreases in both periods were primarily attributable to the activities mentioned above for sales. Adjustments not related to volume, including net profit booking rate adjustments, for both the quarter and nine months ended September 28, 2014 were comparable to the quarter and nine months ended September 29, 2013.

We expect IS&GS' net sales to decline in 2014 in the high single digit percentage range as compared to 2013 primarily due to the continued downturn in federal information technology budgets. Operating profit is also expected to decline in 2014 in the high single digit percentage range consistent with the expected decline in net sales, resulting in margins that are comparable with 2013 results.

36 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Missiles and Fire Control Summary operating results for our MFC business segment were as follows (in millions): Quarters Ended Nine Months Ended September 28, September 29, September 28, September 29, 2014 2013 2014 2013 Net sales $ 1,908 $ 2,003 $ 5,666 $ 6,034 Operating profit 335 356 1,038 1,081 Operating margins 17.6% 17.8% 18.3% 17.9% MFC's net sales for the quarter ended September 28, 2014 decreased $95 million, or 5%, compared to the quarter ended September 29, 2013. The decrease was primarily attributable to lower net sales of approximately $95 million for various technical services programs due to lower volume reflecting market pressures; and about $70 million for tactical missile programs due to fewer missile and launcher deliveries (including GMLRS). The decreases were partially offset by higher net sales of about $60 million for various programs due to increased volume. Net sales for air and missile defense programs were comparable as increased volume for Terminal High-Altitude Area Defense (THAAD) was offset by fewer deliveries for the Patriot Advanced Capability-3 (PAC-3) program.

MFC's operating profit for the quarter ended September 28, 2014 decreased $21 million, or 6%, compared to the quarter ended September 29, 2013. The decrease was primarily attributable to lower operating profit of approximately $20 million for various technical services programs due to lower volume and reserves recorded on certain programs. Adjustments not related to volume, including net profit booking rate adjustments and other matters, were approximately $15 million lower for the quarter ended September 28, 2014 compared to the quarter ended September 29, 2013.

MFC's net sales for the nine months ended September 28, 2014 decreased $368 million, or 6%, compared to the nine months ended September 29, 2013. The decrease was primarily attributable to lower net sales of approximately $340 million for various technical services programs due to lower volume reflecting market pressures; and about $225 million for tactical missiles programs due to fewer missile and launcher deliveries. The decreases were partially offset by higher net sales of about $120 million for fire control programs due to increased deliveries (including Apache programs); and approximately $70 million for various other programs due to increased volume. Net sales for air and missile defense programs were comparable as increased volume for THAAD was offset by fewer deliveries for the PAC-3 program.

MFC's operating profit for the nine months ended September 28, 2014 decreased $43 million, or 4%, compared to the nine months ended September 29, 2013. The decrease was primarily attributable to lower operating profit of approximately $30 million for various technical services programs due to lower volume and reserves recorded on certain programs; and about $45 million for various programs due to lower risk retirements and net warranty reserve adjustments (including JASSM and GMLRS). The decreases were partially offset by higher operating profit of about $20 million for fire control programs due to higher volume and risk retirements (including Apache programs); and approximately $20 million for air and missile defense programs due to higher volume and risk retirements for THAAD. The increase in operating margin was due to the reduction in volume of various technical services programs which have a lower operating margin compared to MFC's overall operating margin. Adjustments not related to volume, including net profit booking rate adjustments and other matters, were approximately $35 million lower for the nine months ended September 28, 2014 compared to the nine months ended September 29, 2013.

We expect MFC's net sales to decline in 2014 in the low single digit percentage range as compared to 2013, primarily due to a decrease in net sales on technical services programs partially offset by an increase in net sales from missiles and fire control programs. Operating profit is expected to decrease in the mid-single digit percentage range, driven by a reduction in expected risk retirements in 2014. Accordingly, operating profit margin is expected to decline in 2014 from 2013.

37 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Mission Systems and Training Summary operating results for our MST business segment were as follows (in millions): Quarters Ended Nine Months Ended September 28, September 29, September 28, September 29, 2014 2013 2014 2013 Net sales $ 1,679 $ 1,698 $ 5,078 $ 5,298 Operating profit 193 216 628 692 Operating margins 11.5% 12.7% 12.4% 13.1% MST's net sales for the quarter ended September 28, 2014 decreased $19 million, or 1%, compared to the quarter ended September 29, 2013. The decrease was primarily attributable to lower net sales of approximately $30 million for ship and aviation systems programs due to lower volume (primarily the Merlin Capability Sustainment Program). The decrease was partially offset by higher net sales of approximately $25 million for undersea systems programs due to higher volume.

MST's operating profit for the quarter ended September 28, 2014 decreased $23 million, or 11%, compared to the quarter ended September 29, 2013. The decrease was primarily attributable to lower operating profit of approximately $35 million for integrated warfare systems and sensor programs due to lower risk retirements (primarily radar surveillance programs). Adjustments not related to volume, including net profit booking rate adjustments, were approximately $20 million lower for the quarter ended September 28, 2014 compared to the quarter ended September 29, 2013.

MST's net sales for the nine months ended September 28, 2014 decreased $220 million, or 4%, compared to the nine months ended September 29, 2013. The decrease was primarily attributable to lower net sales of approximately $80 million for undersea systems programs due to lower volume; about $80 million for integrated warfare systems and sensors programs due to lower volume (primarily electronic warfare, radar surveillance programs and Aegis); and approximately $30 million for the settlements of contract cost matters on certain programs during the nine months ended September 29, 2013 (including a portion of the terminated presidential helicopter program) that were not repeated in 2014.

MST's operating profit for the nine months ended September 28, 2014 decreased $64 million, or 9%, compared to the nine months ended September 29, 2013. The decrease was primarily attributable to lower operating profit of approximately $75 million due to the settlements of contract cost matters on certain programs in the nine months ended September 29, 2013 (including a portion of the terminated presidential helicopter program) that were not repeated in 2014; and approximately $60 million due to reserves recorded on certain training and logistics solutions programs. The decreases were partially offset by higher operating profit of approximately $40 million for performance matters and reserves recorded in the nine months ended September 29, 2013 that were not repeated in 2014; and about $30 million for ship and aviation systems programs due to increased risk retirements (primarily MH-60). Adjustments not related to volume, including net profit booking rate adjustments and other matters, were approximately $60 million lower for the nine months ended September 28, 2014 compared to the nine months ended September 29, 2013.

We expect MST's net sales to decrease slightly in 2014 compared to 2013.

Operating profit is also expected to decrease in the high single digit percentage range from 2013 primarily due to the absence of favorable contractual resolutions that occurred in 2013 as described above and expected charges, net of recoveries, in 2014 for incremental costs related to the November 2013 restructuring plan described in the "Consolidated Results of Operations" section above, resulting in a decline in operating margins between the years.

38 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Space Systems Summary operating results for our Space Systems business segment were as follows (in millions): Quarters Ended Nine Months Ended September 28, September 29, September 28, September 29, 2014 2013 2014 2013 Net sales $ 2,034 $ 1,955 $ 5,741 $ 6,002 Operating profit 281 284 783 790 Operating margins 13.8% 14.5% 13.6% 13.2% Space Systems' net sales for the quarter ended September 28, 2014 increased $79 million, or 4%, compared to the quarter ended September 29, 2013. The increase was primarily attributable to higher net sales of approximately $145 million for commercial space transportation programs due to launch-related activities; and about $70 million for the Orion program due to increased volume. The increases were partially offset by lower net sales of approximately $140 million for government satellite programs due to lower volume (primarily AEHF).

Space Systems' operating profit for the quarter ended September 28, 2014 was comparable to the quarter ended September 29, 2013. Operating profit decreased by approximately $30 million for government satellite programs due to lower volume and risk retirements (primarily AEHF). Operating profit increased by approximately $20 million due to higher equity earnings for joint ventures.

Adjustments not related to volume, including net profit booking rate adjustments, were approximately $15 million lower for the quarter ended September 28, 2014 compared to the quarter ended September 29, 2013.

Space Systems' net sales for the nine months ended September 28, 2014 decreased $261 million, or 4%, compared to the nine months ended September 29, 2013. The decrease was primarily attributable to lower net sales of approximately $400 million for government satellite programs due to lower volume (primarily AEHF, MUOS and GPS-III). The decrease was partially offset by higher net sales of approximately $145 million for commercial space transportation programs due to launch-related activities.

Space Systems' operating profit for the nine months ended September 28, 2014 was comparable to the nine months ended September 29, 2013. Operating profit decreased by approximately $55 million for government satellite programs due to lower volume and risk retirements (including AEHF). Operating profit increased by approximately $35 million due to higher equity earnings for joint ventures; and about $15 million for various programs (including commercial space transportation programs due to launch-related activities). Adjustments not related to volume, including net profit booking rate adjustments, were approximately $30 million lower for the nine months ended September 28, 2014 compared to the nine months ended September 29, 2013.

Total equity earnings (primarily ULA) recognized by Space Systems represented approximately $90 million, or 32%, and approximately $240 million, or 31%, of this business segment's operating profit for the quarter and nine months ended September 28, 2014, compared to approximately $70 million, or 25%, and approximately $210 million, or 27%, for the quarter and nine months ended September 29, 2013.

We expect Space Systems' net sales to remain flat in 2014 compared to 2013.

Operating profit is expected to decline in the mid-single digit percentage range in 2014 primarily due to lower earnings on satellite programs, expected charges, net of recoveries, in 2014 for accelerated depreciation expense and incremental costs related to the November 2013 restructuring plan described in the "Consolidated Results of Operations" section above, and lower equity earnings.

Operating margins are expected to decline slightly between the years.

39 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) FINANCIAL CONDITION Liquidity and Cash Flows We have a balanced cash deployment strategy to enhance stockholder value and position ourselves to take advantage of new business opportunities when they arise. Consistent with that strategy, we have invested in our business, including capital expenditures and independent research and development, returned cash to stockholders through dividends and share repurchases, made selective business acquisitions, and managed our debt levels.

We have generated strong operating cash flows, which have been the primary source of funding for our operations, capital expenditures, acquisitions, debt service and repayments, dividends, share repurchases, and postretirement benefit plan contributions. We have accessed the capital markets on limited occasions, as needed or when opportunistic. We expect our cash from operations will continue to be sufficient to support our operations and anticipated capital expenditures for the foreseeable future. As mentioned in the "Capital Resources" section below, we have financing resources available to fund potential cash outflows that are less predictable or more discretionary, should they occur. We also have access to credit markets, if needed, for liquidity or general corporate purposes, including, but not limited to, our revolving credit facility or the ability to issue commercial paper, and letters of credit to support customer advance payments and for other trade finance purposes such as guaranteeing our performance on particular contracts.

The following table provides a summary of our cash flow information followed by a discussion of the key elements (in millions): Nine Months Ended September 28, September 29, 2014 2013 Cash and cash equivalents at beginning of period $ 2,617 $ 1,898 Operating activities Net earnings 2,710 2,493 Non-cash adjustments 854 884 Changes in working capital (27) (568) Other, net 530 799 Net cash provided by operating activities 4,067 3,608 Net cash used for investing activities (1,064) (784) Net cash used for financing activities (2,657) (2,061) Net change in cash and cash equivalents 346 763 Cash and cash equivalents at end of period $ 2,963 $ 2,661 Operating Activities Net cash provided by operating activities increased $459 million in the nine months ended September 28, 2014 compared to the nine months ended September 29, 2013. The increase was driven by changes in working capital, lower pension contributions, and improved operating results. The $541 million increase in cash flows related to working capital changes (defined as receivables, net and inventories, net less accounts payable and customer advances and amounts in excess of costs incurred) was primarily attributable to a reduction in payments made to suppliers due to timing. We made $1.0 billion in contributions to our qualified defined benefit pension plans during the nine months ended September 29, 2014 compared to $1.5 billion during the nine months ended September 29, 2013, and we anticipate contributing an incremental $1.0 billion in the fourth quarter of 2014. Partially offsetting the improved cash flows was an increase in net tax payments. We made net tax payments of approximately $1.0 billion and $387 million during the nine months ended September 28, 2014 and September 29, 2013, which are net of $200 million and $550 million in tax refunds primarily attributable to our tax-deductible pension contributions made during the quarters ended December 31, 2013 and 2012.

40 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Investing Activities The majority of our capital expenditures were for equipment and facilities infrastructure that generally are incurred to support new and existing programs across all of our business segments. We also incur capital expenditures for information technology to support programs and general enterprise information technology infrastructure, inclusive of costs for development or purchase of internal-use software. Capital expenditures were $456 million and $491 million for the nine months ended September 28, 2014 and September 29, 2013.

During the nine months ended September 28, 2014, we paid $622 million related to the acquisitions of businesses and investments in affiliates, compared to $266 million during the nine months ended September 29, 2013 (Note 8, under the caption "Acquisitions").

Financing Activities We paid $1.7 billion and $1.5 billion to repurchase 10.3 million and 14.5 million shares of our common stock during the nine months ended September 28, 2014 and September 29, 2013. On September 25, 2014, our Board of Directors approved a $2.0 billion increase to our share repurchase program.

Inclusive of this increase, the total remaining authorization for future common share repurchases under our program was $3.9 billion as of September 28, 2014.

We anticipate at least $2.0 billion of share repurchases in 2015, subject to market conditions and management's discretion.

Cash received from the issuance of our common stock in connection with employee stock option exercises during the nine months ended September 28, 2014 and September 29, 2013 totaled $278 million and $749 million. Those exercises resulted in the issuance of 3.3 million shares and 9.1 million shares of our common stock during the respective periods.

During the nine months ended September 28, 2014, we paid dividends totaling $1.3 billion, which consisted of our 2014 first, second, and third quarter dividends ($1.33 per share each quarter) and dividend-equivalent cash payments associated with the vesting of the January 2011 restricted stock unit grants. During the quarter ended September 28, 2014, we also declared our 2014 fourth quarter dividend of $1.50 per share, a per share increase of 13% over our 2014 third quarter dividend. During the nine months ended September 29, 2013, we paid dividends totaling $1.1 billion, which consisted of our 2013 first, second, and third quarter dividends ($1.15 per share each quarter).

Also, during the nine months ended September 29, 2013, we repaid $150 million of long-term notes with a fixed interest rate of 7.38% due to their scheduled maturities.

Capital Resources At September 28, 2014, we held cash and cash equivalents of $3.0 billion. As of September 28, 2014, approximately $500 million of our cash and cash equivalents was held outside of the U.S. by foreign subsidiaries. Although those balances are generally available to fund ordinary business operations without legal or other restrictions, a significant portion is not immediately available to fund U.S. operations unless repatriated. Our intention is to permanently reinvest earnings from our foreign subsidiaries. While we do not intend to do so, if this cash had been repatriated at September 28, 2014, the amount of additional U.S.

federal income tax that would be due after considering foreign tax credits would not be significant.

Our outstanding debt, net of unamortized discounts, amounted to $6.2 billion, and mainly is in the form of publicly-issued notes that bear interest at fixed rates. As of September 28, 2014, we were in compliance with all covenants contained in our debt and credit agreements.

In August 2014, we entered into a new $1.5 billion revolving credit facility with a syndicate of banks and concurrently terminated our existing $1.5 billion revolving credit facility which was scheduled to expire in August 2016. We may request and the banks may grant, at their discretion, an increase to the new credit facility up to an additional $500 million. The credit facility also includes a sublimit of up to $300 million available for the issuance of letters of credit. The new credit 41 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) facility expires in August 2019. There were no borrowings outstanding under the new credit facility through September 28, 2014. We also have agreements in place with financial institutions to provide for the issuance of commercial paper.

There were no commercial paper borrowings outstanding through September 28, 2014. If we were to issue commercial paper, the borrowings would be supported by the credit facility. We also have an effective shelf registration statement on Form S-3 on file with the U.S. Securities and Exchange Commission to provide for the issuance of an indeterminate amount of debt securities.

Our stockholders' equity was $4.6 billion at September 28, 2014, a decrease of $344 million from December 31, 2013. The decrease was primarily due to dividends declared of $1.8 billion, the repurchase of 10.3 million shares of our common stock for $1.7 billion, and the re-measurements of the assets and benefit obligations related to substantially all of our defined benefit pension plans of $735 million (Note 5) during the nine months ended September 28, 2014. These decreases were partially offset by net earnings of $2.7 billion, employee stock-based award activity of $648 million, and the recognition of net actuarial losses and amortization of prior service costs related to our postretirement benefit plans of $520 million during the nine months ended September 28, 2014.

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.

OTHER MATTERS Status of the F-35 Program The F-35 program consists of a development contract and multiple production contracts. The development contract is being performed concurrent with the production contracts. Concurrent performance of development and production contracts is used for complex programs to test aircraft, shorten the time to field systems, and achieve overall cost savings. We expect the development portion of the F-35 program will be substantially complete in 2017, with less significant efforts continuing into 2019. Production of the aircraft is expected to continue for many years given the U.S. Government's current inventory objective of 2,443 aircraft for the Air Force, Marine Corps, and Navy; commitments from our eight international partners and three international customers; as well as expressions of interest from other countries.

The U.S. Government continues to complete various operational tests, including ship trials, mission system evaluations, and weapons testing, with the F-35 aircraft fleet recently surpassing 22,000 flight hours. Progress continues to be made on the production of aircraft. As of September 28, 2014, we have delivered 95 production aircraft to our domestic and international partners including delivery of the final low-rate initial production contract 5 aircraft, and have 71 production aircraft in backlog, including orders from our international partners.

Given the size and complexity of the F-35 program, we anticipate that there will be continual reviews related to aircraft performance, program schedule, cost, and requirements as part of the DoD, Congressional, and international partners' oversight and budgeting processes. Current program challenges include, but are not limited to, supplier and partner performance, software development, level of cost associated with lifecycle operations and sustainment and warranties, receiving funding for production contracts on a timely basis, executing future flight tests, findings resulting from testing, and operating the aircraft.

Contingencies See Note 6 for information regarding our contingent obligations, including off-balance sheet arrangements.

42 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Critical Accounting Policies There have been no significant changes to the critical accounting policies we disclosed in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2013 Form 10-K. However, as set forth below, we have updated our disclosures related to our postretirement benefit plans and goodwill to reflect recent activity.

Postretirement Benefit Plans Plan Amendments and Re-measurements In June 2014, we amended certain of our qualified and nonqualified defined benefit pension plans for non-union employees to freeze future retirement benefits. The freeze will take effect in two stages. Beginning on January 1, 2016, the pay-based component of the formula used to determine retirement benefits will be frozen so that future pay increases, annual incentive bonuses, or other amounts earned for or related to periods after December 31, 2015 will not be used to calculate retirement benefits. On January 1, 2020, the service-based component of the formula used to determine retirement benefits will also be frozen so that participants will no longer earn further credited service for any period after December 31, 2019. When the freeze is complete, the majority of our salaried employees will have transitioned to an enhanced defined contribution retirement savings plan.

As a result of these plan amendments, we were required to re-measure the assets and benefit obligations for the affected defined benefit pension plans in June 2014. We also elected to re-measure the assets and benefit obligations of substantially all other defined benefit pension plans in June 2014 to align the measurement date across substantially all of our defined benefit pension plans.

These re-measurements also incorporated updated actuarial assumptions (described below), including new longevity assumptions (also described below).

As a result of the re-measurements, in June 2014 we recorded a net increase of $1.1 billion to our qualified defined benefit pension obligations and a net increase of $79 million to our nonqualified defined benefit pension obligations, which combined resulted in a corresponding increase of $735 million to other comprehensive loss, net of $402 million of tax benefits. We expect our 2014 FAS pension expense will be about $1.2 billion. See Note 5 for additional information regarding the plan amendments and re-measurements.

When calculating our benefit obligations related to our defined benefit pension plans in June 2014, we utilized a discount rate of 4.25% compared to 4.75% at December 31, 2013. We evaluated several data points in determining an appropriate discount rate, including results from cash flow models, quoted rates from long-term bond indices, and changes in long-term bond rates over the past year. As part of our evaluation, we calculated the approximate average yields on corporate bonds rated AA or better selected to match our projected postretirement benefit plan cash flows.

Longevity assumptions are used to estimate the life expectancy of plan participants during which they are expected to receive benefit payments. Recent actuarial studies indicate life expectancies are longer and would have the resultant effect of increasing the total expected benefit payments to plan participants. Our re-measurements reflected the use of new longevity assumptions.

For the asset return assumption at the re-measurement date, we utilized an expected long-term rate of return on plan assets of 8.00%, consistent with the rate used at December 31, 2013. The long-term rate of return assumption represents the expected long-term rate of return on the funds invested, or to be invested, to provide for the benefits included in the benefit obligations. This assumption is based on several factors including historical market index returns, the anticipated long-term allocation of plan assets, the historical return data for the trust funds, plan expenses, and the potential to outperform market index returns. The difference between the long-term rate of return on plan assets assumption we select and the actual return on plan assets in any given year affects both the funded status of our benefit plans and the calculation of FAS pension expense in subsequent periods. Although the actual return in any specific year likely will differ from the assumption, the average expected return over a long-term future horizon should be approximately equal to the assumption. As a result, changes in this assumption are less frequent than changes in the discount rate.

43 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Funding Considerations During the quarter and nine months ended September 28, 2014, we made contributions of $485 million and $1.0 billion to our qualified defined benefit pension plans, and we anticipate contributing an incremental $1.0 billion in the fourth quarter of 2014. Funding of our defined benefit pension plans is determined in a manner consistent with CAS and in accordance with the Employee Retirement Income Security Act of 1974 (ERISA), as amended by the Pension Protection Act of 2006 (PPA). In July 2012, the U.S. Government passed the Moving Ahead for Progress in the 21st Century Act of 2012 (MAP-21), which included a provision that changed the methodology for calculating the interest rate assumption used in determining the minimum funding requirements under the PPA. As a result of MAP-21 there was an increase in the interest rate assumption, which in turn lowered the minimum funding requirements. The impact of MAP-21 decreased each year and was scheduled to phase out by 2016. On August 8, 2014, the HATFA was enacted, which extends the methodology put in place by MAP-21 to calculate the interest rate assumption so that the impact will begin to decrease in 2018 and phase out by 2021. Accordingly, the HATFA has the effect of lowering our minimum funding requirements during the affected periods from what they otherwise would have been had the MAP-21 methodology not been extended.

Contributions to our defined benefit pension plans are recovered over time through the pricing of our products and services on U.S. Government contracts, including FMS, and are recognized in our cost of sales and net sales. CAS govern the extent to which our pension costs are allocable to and recoverable under contracts with the U.S. Government, including FMS. The enactment of the HATFA also increased the interest rate assumption used to determine our CAS pension costs, which has the effect of lowering the recovery of pension contributions during the affected periods as it decreases our CAS pension costs. In the quarter ended September 28, 2014, we adjusted our 2014 CAS pension cost to reflect the higher interest rate provisions of the HATFA retroactive to the beginning of 2014. As a result, we expect to reduce our 2014 CAS pension cost by $70 million, of which $55 million (including $35 million related to the first six months of 2014) was recognized during the quarter ended September 28, 2014.

We now expect our total CAS pension cost to be approximately $1.5 billion and FAS/CAS income to be $375 million in 2014, inclusive of the effects of the HATFA. The HATFA and MAP-21 legislation does not impact our FAS pension expense.

Pension cost recoveries under CAS occur in different periods from when pension contributions are made under the PPA. Amounts contributed in excess of the CAS pension costs recovered under U.S. Government contracts are considered to be prepayment credits under the CAS rules. As of September 28, 2014, our prepayment credits were approximately $10.0 billion, inclusive of the impacts of HATFA, as compared to $9.6 billion at December 31, 2013. The prepayment balance will increase or decrease based on our actual investment return on plan assets. Our CAS prepayment credits were not impacted by the re-measurements of the assets and benefit obligations of substantially all of our defined benefit pension plans in June 2014.

Trends We expect 2015 FAS/CAS pension income of approximately $650 million assuming a 4.25% discount rate at the end of 2014, the same rate used for the re-measurement of our defined benefit pension obligations in June 2014, an 8.00% actual return on plan assets in 2014 and incremental pension contributions of $1.0 billion anticipated in the fourth quarter of 2014, 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 $120 million to the estimated 2015 FAS/CAS pension income. With these same assumptions, FAS/CAS pension income is expected to increase sequentially at an approximate 50% rate annually through 2017.

We do not expect to make contributions to our qualified defined benefit pension plans in 2015 through 2017. However, we anticipate recovering approximately $1.6 billion of CAS pension cost in 2015 and our CAS recoveries in 2016 and 2017 to be sequentially higher than in 2015 as we begin to recover the $10.0 billion of prepayment credits at September 28, 2014 under the CAS rules.

44 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation Management's Discussion and Analysis of Financial Condition and Results of Operations (continued) Accounting for postretirement benefit plans under GAAP requires that the amounts we record are computed using actuarial valuations. These valuations include many assumptions, including those we make regarding financial markets and other economic conditions. Changes in those annual assumptions can impact our total stockholders' equity at any given year-end, and the amount of expense we record for our postretirement benefits plans in the following year. We will finalize the postretirement benefit plan assumptions and determine the 2014 actual return on plan assets on December 31, 2014. The final assumptions for 2014 may differ materially from those discussed above, as well as the actual investment returns on plan assets for 2014.

Goodwill We continue to experience uncertainty in our business environment due to significant fiscal and economic challenges facing the U.S. Government, our primary customer, as well as market pressures. While initiatives such as the Bipartisan Budget Act of 2013 provide a more measured and strategic approach to addressing the U.S. Government's fiscal challenges, budget reductions, including sequestration, remain a long-term concern as the act retained sequestration cuts for GFYs 2016 through 2021 and the across-the-board spending reduction methodology provided for in the Budget Control Act of 2011. Generally, our businesses with smaller, short-term contracts are the most susceptible to the impacts of budget reductions, such as our Civil reporting unit within our IS&GS business segment and Technical Services (TS) reporting unit within our MFC business segment. These reporting units have also been adversely impacted by increased market pressures including lower in-theater support as troop levels are drawn down and increased re-competition coupled with the fragmentation of large contracts into multiple smaller contracts that are awarded primarily on the basis of price.

The carrying values of our Civil and TS reporting units included goodwill of $1.9 billion and $270 million as of September 28, 2014. Currently, we estimate that the fair values of our Civil and TS reporting units exceed their carrying values by margins of approximately 15%. Budget reductions, contract cancellations and terminations, or market pressures could cause our sales, earnings, and cash flows to further decline below our current projections.

Similarly, changes in market factors utilized in the impairment analysis, including long-term growth rates, discount rates, and relevant comparable public company earnings multiples and transaction multiples, could negatively impact the fair value of our reporting units. Based on our current assessment of these circumstances we have determined that our Civil and TS reporting units are at risk of a future goodwill impairment should there be further deterioration of projected cash flows, negative changes in market factors, or a significant increase in the carrying value of these reporting units.

Impairment assessments inherently involve management judgments regarding a number of assumptions described above. Due to the many variables inherent in the estimation of a reporting unit's fair value and the relative size of our recorded goodwill, differences in assumptions could have a material effect on the estimated fair value of one or more of our reporting units and could result in a goodwill impairment charge in a future period. We will complete our 2014 annual impairment test of goodwill in the fourth quarter and our risk and impairment conclusions may change.

Recent Accounting Pronouncements In May 2014, the Financial Accounting Standards Board (FASB) issued a new standard that will change the way we recognize revenue and significantly expand the disclosure requirements for revenue recognition. Unless the FASB delays the effective date of the new standard, it will be effective for us beginning on January 1, 2017. See Note 8 (under the caption "New Accounting Pronouncements") for additional information related to this new standard.

45 -------------------------------------------------------------------------------- Table of Contents Lockheed Martin Corporation

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