LOCKHEED MARTIN : Management's Discussion and Analysis of Financial Condition and Results of Operations (form 10-K)

Business Overview
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations (MD&A) is intended to help the reader understand our
results of operations and financial condition. The MD&A is provided as a
supplement to, and should be read in conjunction with, our consolidated
financial statements and notes thereto included in Item 8 - Financial Statements
and Supplementary Data.
The MD&A generally discusses 2019 and 2018 items and year-to-year comparisons
between 2019 and 2018. Discussions of 2017 items and year-to-year comparisons
between 2018 and 2017 that are not included in this Form 10-K can be found in
"Management's Discussion and Analysis of Financial Condition and Results or
Operations" in the Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 2018 filed with the SEC on February 8, 2019.
We are a global security and aerospace company principally engaged in the
research, design, development, manufacture, integration and sustainment of
advanced technology systems, products and services. We also provide a broad
range of management, engineering, technical, scientific, logistics, system
integration and cybersecurity services. We serve both U.S. and international
customers with products and services that have defense, civil and commercial
applications, with our principal customers being agencies of the U.S.
Government. In 2019, 71% of our $59.8 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)), 28% 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 cybersecurity.
We operate in four business segments: Aeronautics, Missiles and Fire Control
(MFC), Rotary and Mission Systems (RMS) and Space. We organize our business
segments based on the nature of the products and services offered.
We operate in an environment characterized by both complexity in global security
and continuing economic pressures in the U.S. and globally. A significant
component of our strategy in this environment is to focus on program execution,
improving the quality and predictability of the delivery of our products and
services, and placing security capability quickly into the hands of our U.S. and
international customers at affordable prices. Recognizing that our customers are
resource constrained, we are endeavoring to develop and extend our portfolio
domestically in a disciplined manner with a focus on adjacent markets close to
our core capabilities, as well as growing our international sales. We continue
to focus on affordability initiatives. We also expect to continue to innovate
and invest in technologies to fulfill new mission requirements for our customers
and invest in our people so that we have the technical skills necessary to
succeed without limiting our ability to return a substantial portion of our free
cash flow to our investors in the form of dividends and share repurchases. We
define free cash flow as cash from operations as determined under U.S. generally
accepted accounting principles (GAAP), less capital expenditures as presented on
our consolidated statements of cash flows.
2020 Financial Trends
We expect our 2020 net sales to increase in the mid-single digit range from 2019
levels. The projected growth is driven by increased volume at all four business
areas. Specifically, the increased growth is driven by the F-35 program at
Aeronautics, increased volume in the tactical and strike missiles and air and
missile defense businesses at MFC, Sikorsky volume at RMS, and hypersonics
volume at Space. Total business segment operating profit margin in 2020 is
expected to be approximately 10.8%; and cash from operations is expected to be
greater than or equal to $7.6 billion. The preliminary outlook for 2020 assumes
the U.S. Government continues to support and fund our key programs. Changes in
circumstances may require us to revise our assumptions, which could materially
change our current estimate of 2020 net sales, operating margin and cash flows.
We expect a net FAS/CAS pension benefit of approximately $2.1 billion in 2020
based on a 3.25% discount rate (a 100 basis point decrease from the end of
2018), an approximate 21% return on plan assets in 2019, a 7.00% expected
long-term rate of return on plan assets in future years, and the revised
longevity assumptions released during the fourth quarter of 2019 by the Society
of Actuaries. We do not expect to make any contributions to our qualified
defined benefit pension plans in 2020 and anticipate recovering approximately
$2.0 billion of CAS pension cost.
As previously announced on July 1, 2014, we completed the final step of the
planned freeze of our qualified and nonqualified defined benefit pension plans
for salaried employees effective January 1, 2020. The service-based component of
the formula used to determine retirement benefits is frozen such that
participants are no longer earning further credited service for any period after
December 31, 2019. As a result of these changes, the plans are fully frozen
effective January 1, 2020. Retirees already collecting

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benefits and former employees with a vested benefit were not affected by the
change. Current employees also will retain all benefits already earned in their
pension plan to date.
Portfolio Shaping Activities
We continuously strive to strengthen our portfolio of products and services to
meet the current and future needs of our customers. We accomplish this in part
by our independent research and development activities and through acquisition,
divestiture and internal realignment activities.
We selectively pursue the acquisition of businesses and investments at
attractive valuations that will expand or complement our current portfolio and
allow access to new customers or technologies. We also may explore the
divestiture of businesses that no longer meet our needs or strategy or that
could perform better outside of our organization. In pursuing our business
strategy, we routinely conduct discussions, evaluate targets and enter into
agreements regarding possible acquisitions, divestitures, joint ventures and
equity investments.
Divestiture of Distributed Energy Solutions
On November 18, 2019, we completed the sale of our Distributed Energy Solutions
(DES) business, a commercial energy service provider that was part of our MFC
business segment. We received $225 million in cash from the sale and recognized
a gain of $34 million (approximately $0 after-tax) for the sale. Amounts related
to this divestiture were not significant to the corporation and the sale did not
represent a strategic shift, and accordingly, the operating results, financial
position and cash flows for the DES business have not been reclassified to
discontinued operations.
Industry Considerations
U.S. Government Funding
On December 20, 2019, the President signed the annual fiscal year (FY) 2020
appropriations, funding the DoD and other government agencies (a U.S. Government
fiscal year starts on October 1 and ends on September 30). The appropriations
provide $738 billion in discretionary funding for national defense, including
$667 billion in base funding and $71 billion in Overseas Contingency Operations
(OCO)/emergency funding (OCO and emergency supplemental funding do not count
toward discretionary spending caps). Of the $738 billion, the DoD is allocated
$709 billion; composed of $637 billion in base funding and $72 billion in OCO
and emergency funding.
The approved funding is in accordance with the Bipartisan Budget Act of 2019
(BBA-19), which was enacted on August 2, 2019. The BBA-19 increased the spending
limits for both defense and non-defense discretionary funding for the U.S.
Government FY 2020 and 2021 set under the Budget Control Act of 2011 (BCA). The
defense spending limits were increased by $90 billion to $667 billion for FY
2020 and by $81 billion to $672 billion for FY 2021. When combined with approved
OCO/emergency funding, the agreement raised top-line spending for national
defense to the $738 billion enacted in FY 2020 and $741 billion in FY 2021. By
raising the spending limits, the BBA-19 essentially ended the budgetary
constraints implemented by the 2011 BCA. Additionally, the BBA-19 also suspended
the debt ceiling through July 31, 2021, at which time the debt limit will be
increased to the amount of U.S. Government debt outstanding on that date.
International Business
A key component of our strategic plan is to grow our international sales. To
accomplish this growth, we continue to focus on strengthening our relationships
internationally through partnerships and joint technology efforts. We conduct
business with international customers through each of our business segments
through either FMS or direct sales to international customers. See Item 1A -
Risk Factors for a discussion of risks related to international sales.
International customers accounted for 37% of Aeronautics' 2019 net sales. There
continues to be strong international interest in the F-35 program, which
includes commitments from the U.S. Government and eight international partner
countries and four international customers, as well as expressions of interest
from other countries. The U.S. Government and the partner countries continue to
work together on the design, testing, production, and sustainment of the F-35
program. While, in July 2019, the DoD announced plans to remove Turkey, who had
previously committed to purchase up to 100 F-35 aircraft, from the F-35 program,
we received congressional notification of approval of the proposed sale of 32
F-35A aircraft to Poland in the third quarter of 2019. Additionally, in January
2019, Singapore announced its selection of the F-35 as their next generation
fighter. Singapore's initial request is for four F-35s, with the option of eight
additional aircraft. Other areas of international expansion at our Aeronautics
business segment include the F-16 program. In August 2019, the Bulgarian
government and the U.S. Government signed a letter of offer and acceptance worth
$1.26 billion regarding Bulgaria's planned procurement of eight new production
F-16 Block 70 aircraft for the Bulgarian Air Force.

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In 2019, international customers accounted for 24% of MFC's net sales. Our MFC
business segment continues to generate significant international interest, most
notably in the air and missile defense product line, which produces the Patriot
Advanced Capability-3 (PAC-3) and Terminal High Altitude Area Defense (THAAD)
systems. The PAC-3 is an advanced missile defense system designed to intercept
incoming airborne threats. We have ongoing PAC-3 programs for production and
sustainment activities in Qatar, the Kingdom of Saudi Arabia, UAE, Japan, the
Republic of Korea, Poland and Taiwan. THAAD is an integrated system designed to
protect against high altitude ballistic missile threats. UAE and the Kingdom of
Saudi Arabia are international customers for THAAD, and other countries in the
Middle East, Europe and the Asia-Pacific region have also expressed interest in
our air and missile defense systems. Additionally, we continue to see
international demand for our tactical missile and fire control products, where
we received orders for Apache and Low Altitude Navigation and Targeting Infrared
for Night (LANTIRN®) systems for Qatar, and precision fires systems from Poland
and Romania. Other MFC international customers include the United Kingdom,
Germany, India, Kuwait and Bahrain.
In 2019, international customers accounted for 25% of RMS' net sales. Our RMS
business segment continues to experience international interest in the Aegis
Ballistic Missile Defense System (Aegis). We perform activities in the
development, production, modernization, ship integration, test and lifetime
support for ships of international customers such as Japan, Spain, Republic of
Korea, and Australia. We have ongoing programs in Canada and Chile for combat
systems equipment upgrades on Halifax-class and Type 23 frigates. Our
Multi-Mission Surface Combatant (MMSC) program provides surface combatant ships
for international customers, such as the Kingdom of Saudi Arabia, designed to
operate in shallow waters and the open ocean. In our training and logistics
solutions portfolio, we have active programs and pursuits in the United Kingdom,
the Kingdom of Saudi Arabia, Canada, Egypt, Singapore, and Australia. We have
active development, production, and sustainment support of the S-70i Black Hawk®
and MH-60 Seahawk® aircraft to foreign military customers, including Chile,
Australia, Denmark, Taiwan, the Kingdom of Saudi Arabia and Colombia. Commercial
aircraft are sold to customers in the oil and gas industry, emergency medical
evacuation, search and rescue fleets, and VIP customers in over 30 countries.
International customers accounted for 14% of Space's 2019 net sales. Our Space
business segment includes the operations of AWE Management Limited (AWE), which
operates the United Kingdom's nuclear deterrent program. The work at AWE covers
the entire life cycle, from initial concept, assessment and design, through
component manufacture and assembly, in-service support and decommissioning, and
disposal. In addition, Space has an international contract with Japan to design
and manufacture geostationary communication satellites using the LM2100
satellite platform.
Status of the F-35 Program
The F-35 program primarily consists of production contracts, sustainment
activities, and new development efforts. Production of the aircraft is expected
to continue for many years given the U.S. Government's current inventory
objective of 2,456 aircraft for the U.S. Air Force, U.S. Marine Corps, and U.S.
Navy; commitments from our eight international partner countries and four
international customers; as well as expressions of interest from other
countries.
During 2019, the F-35 program completed several milestones both domestically and
internationally. The U.S. Government continued testing the aircraft, including
ship trials, mission and weapons systems evaluations, and the F-35 fleet
recently surpassed 240,000 flight hours. During 2019, multiple customers
declared Initial Operating Capability including the U.S. Navy for its F-35C
variant, the United Kingdom for its F-35B variant, Japan for its F-35A variant,
and Norway for its F-35A variant. Since program inception, we have delivered 491
production F-35 aircraft, demonstrating the F-35 program's continued progress
and longevity. The first 491 F-35 aircraft delivered to U.S. and international
customers include 347 F-35A variants, 108 F-35B variants, and 36 F-35C variants.
The full-rate production decision, also known formally as Milestone C, is
expected to be delayed by the DoD until Initial Operational Test and Evaluation
(IOT&E) activities are complete in the Naval Air Systems Command (NAVAIR)-led
Joint Simulation Environment (JSE). The JSE is used to conduct simulated
evaluations of the F-35 in a range of high-threat scenarios. Testing is expected
to be completed by the end of 2020. The data will be utilized by the U.S.
Government as part of their evaluation to transition the F-35 program from Low
Rate Initial Production (LRIP) into full-rate production.
During the fourth quarter of 2019, the U.S. Government and Lockheed Martin
finalized a Block Buy agreement for the production and delivery of F-35s in Lots
12, 13 and 14 at the lowest aircraft price in the history of the program.  This
includes amounts previously awarded by the U.S. Government in November 2018 for
the production of 252 Block Buy F-35 aircraft. As part of the fourth quarter
2019 agreement, the U.S. Government awarded the production of an additional 112
F-35 Block Buy Aircraft. We delivered 134 production aircraft in 2019 to our
U.S. and international partner countries, and we have 374 production aircraft in
backlog, including orders from our international partner countries.
On July 17, 2019, the U.S. Government suspended Turkey's participation in the
F-35 program and initiated the process to formally remove Turkey from the
program as a result of Turkey accepting delivery of the Russian S-400 air and
missile defense system. To date, the Administration has not imposed sanctions on
Turkish entities involved in the S-400 procurement, although sanctions under the
Countering America's Adversaries Through Sanctions Act (CAATSA) remain a risk.
Additionally, sanctions

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could be imposed against Turkey as a result of future legislation, including the
"Promoting American National Security and Preventing the Resurgence of ISIS Act
of 2019" that was passed out of the Senate Foreign Relations Committee on
December 11, 2019.  The bill includes significant new sanction provisions
targeted at Turkey that, if enacted, would directly affect Lockheed Martin
programs in Turkey. Turkey could implement retaliatory sanctions if the bill
moves forward in Congress in 2020.We are monitoring these developments and the
potential impacts of any sanctions and other actions regarding Turkey on the
F-35 program and on our other programs involving Turkey. Depending on the scope
and applicability of any sanctions or other actions, the impact could be
material to our operations, operating results, financial position or cash flows.
Turkey is one of eight international partner countries on the F-35 program and
previously committed to purchase up to 100 F-35 aircraft, of which six have
completed production.
Turkish suppliers also produce component parts for the F-35 program, many of
which are single-sourced. To minimize the risks of disruption of our supply
chain and ensure continuity of F-35 production, we have been working closely
with the DoD and supporting activities to identify and engage alternate
suppliers for the component parts produced by Turkish suppliers. We have made
significant progress toward this end but due to the procedure to qualify new
parts and suppliers, this collaborative process between DoD and Lockheed Martin
is ongoing. We are in discussions with the U.S. Government with respect to the
timeline for the transition of Turkish sources. While the transition timeline is
an important first step, it is equally important that our replacement capacity
is re-established so that production is not impacted. Efforts to date have
significantly reduced our risk but final resolution on a limited number of
remaining components could affect F-35 deliveries, including in 2020, and any
accelerated work stoppage would impact cost. International sales of the F-35 are
negotiated between the U.S. Government and international governments and the
process to formally remove Turkey from the F-35 program is a
government-to-government matter. We will continue to follow official U.S.
Government guidance as it relates to delivery of F-35 aircraft to Turkey and the
export and import of component parts from the Turkish supply chain.

The full effects of potential U.S. Government sanctions on Turkey and Turkey's
removal from the F-35 program cannot be determined at this time. However, these
actions could impact the timing of orders, disrupt the production of aircraft,
delay delivery of aircraft, disrupt delivery of sustainment components produced
in Turkey and impact funding on the F-35 program to include the result of any
reprogramming of funds that may be necessary to mitigate the impact of alternate
sources for component parts made in Turkey. While, in the case of the F-35
program, we expect that these costs ultimately would be recovered from the U.S.
Government, the availability or timing of any recovery could adversely affect
our cash flows and results of operations. For additional discussion, including
the risk of sanctions on other programs involving sales to Turkey or work with
Turkish industry, see Item 1A - Risk Factors.
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 partner
countries' oversight and budgeting processes. Current program challenges
include, but are not limited to, supplier and partner performance, software
development, level of cost associated with life cycle 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.

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Consolidated Results of Operations
Our operating cycle is primarily long term and involves many types of contracts
for the design, development and manufacture of products and related activities
with varying delivery schedules. Consequently, the results of operations of a
particular year, or year-to-year comparisons of sales and profits, may not be
indicative of future operating results. The following discussions of comparative
results among years 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):
                                                              2019         2018         2017
Net sales                                                 $ 59,812     $ 53,762     $ 49,960
Cost of sales                                              (51,445 )    (46,488 )    (43,589 )
Gross profit                                                 8,367        7,274        6,371
Other income, net                                              178           60          373
Operating profit (a)(b)(c)(d)                                8,545        7,334        6,744
Interest expense                                              (653 )       (668 )       (651 )
Other non-operating expense, net                              (651 )       (828 )       (847 )
Earnings from continuing operations before income taxes      7,241        5,838        5,246
Income tax expense (e)(f)                                   (1,011 )       (792 )     (3,356 )
Net earnings from continuing operations                      6,230        5,046        1,890
Net earnings from discontinued operations                        -            -           73
Net earnings                                              $  6,230     $  5,046     $  1,963
Diluted earnings per common share
Continuing operations                                     $  21.95     $  17.59     $   6.50
Discontinued operations                                          -            -         0.25
Total diluted earnings per common share                   $  21.95     $  

17.59 $ 6.75

(a) For the year ended December 31, 2018, operating profit includes a non-cash

asset impairment charge of $110 million related to our equity method

investee, Advanced Military Maintenance, Repair and Overhaul Center LLC

(AMMROC). For the year ended December 31, 2017, operating profit includes a

$64 million charge, which represents our portion of a non-cash asset

impairment charge recorded by AMMROC. See "Note 1 - Significant Accounting

     Policies" included in our Notes to Consolidated Financial Statements for
     more information.

(b) For the year ended December 31, 2018, operating profit includes $96 million

of severance and restructuring charges. See "Note 15 - Severance and

Restructuring Charges" included in our Notes to Consolidated Financial

Statements for a discussion of 2018 severance and restructuring charges.

(c)  For the years ended December 31, 2019 and December 31, 2017, operating
     profit includes a previously deferred non-cash gain of approximately $51
     million and $198 million related to properties sold in 2015.


(d)  For the year ended December 31, 2019, operating profit includes a gain of
     $34 million for the sale of our Distributed Energy Solutions business.


(e)  In 2017, we recorded a net one-time tax charge of $2.0 billion ($6.77 per
     share), substantially all of which was non-cash, primarily related to the

estimated impact of the Tax Cuts and Jobs Act. See "Income Tax Expense"

section below and "Note 9 - Income Taxes" included in our Notes to

Consolidated Financial Statements for additional information.

(f) Net earnings for the year ended December 31, 2019 include benefits of $127

million ($0.45 per share) for additional tax deductions for the prior year,

primarily attributable to foreign derived intangible income treatment based

on proposed tax regulations released on March 4, 2019 and our change in tax

accounting method. Net earnings for the year ended December 31, 2018 include

benefits of $146 million ($0.51 per share) for additional tax deductions for

the prior year, primarily attributable to true-ups to the net one-time

charges related to the Tax Cuts and Jobs Act enacted on December 22, 2017

and our change in tax accounting method. See "Income Tax Expense" section

below and "Note 9 - Income Taxes" included in our Notes to Consolidated

Financial Statements for additional information.

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 our discussion
of our business segment results of operations.

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Net Sales
We generate sales from the delivery of products and services to our customers.
Our consolidated net sales were as follows (in millions):
                           2019          2018          2017
Products               $ 50,053      $ 45,005      $ 42,502
% of total net sales       83.7  %       83.7  %       85.1  %
Services                  9,759         8,757         7,458
% of total net sales       16.3  %       16.3  %       14.9  %
Total net sales        $ 59,812      $ 53,762      $ 49,960


Substantially all of our contracts are accounted for using the
percentage-of-completion cost-to-cost method. Under the percentage-of-completion
cost-to-cost method, we record net sales on contracts over time 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
subsequent 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 the percentage-of-completion cost-to-cost method.
Product Sales
Product sales increased $5.0 billion, or 11%, in 2019 as compared to 2018,
primarily due to higher product sales of $2.1 billion at Aeronautics,
$1.5 billion at MFC and $965 million at Space. The increase in product sales at
Aeronautics was primarily due to higher production volume for the F-35 program
and higher volume on classified programs. The increase in product sales at MFC
was primarily due to increased volume for tactical and strike missile programs
(primarily precision fires, new hypersonic development programs, and classified
programs), increased volume for integrated air and missile defense programs
(primarily PAC-3 and THAAD), and increased volume for sensors and global
sustainment programs (primarily Apache). The increase in product sales at Space
was primarily due to higher volume for government satellite programs (primarily
Next Generation Overhead Persistent Infrared (Next Gen OPIR) and Global
Positioning System (GPS III)) and higher volume for strategic and missile
defense programs (primarily new hypersonic development programs).
Service Sales
Service sales increased $1.0 billion, or 11%, in 2019 as compared to 2018,
primarily due to an increase in service sales of about $385 million at RMS,
$340 million at Aeronautics and $190 million at MFC. The increase in service
sales at RMS was primarily due to higher volume of various training and
logistics solutions programs (primarily an army sustainment program), and
integrated warfare systems and sensors (IWSS) programs (primarily Aegis Combat
System (Aegis)). Higher service sales at Aeronautics were primarily due to
higher sustainment volume for the F-35 and F-22 programs. The increase in
service sales at MFC was primarily attributable to increased volume for sensors
and global sustainment programs (primarily Special Operations Forces Global
Logistics Support Services (SOF GLSS)) and higher sustainment volume for the
PAC-3 program.


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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 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):
                                           2019            2018            2017
Cost of sales - products              $ (44,589 )     $ (40,293 )     $ (38,417 )
% of product sales                         89.1   %        89.5   %        90.4   %
Cost of sales - services                 (8,731 )        (7,738 )        (6,673 )
% of service sales                         89.5   %        88.4   %        89.5   %
Severance and restructuring charges           -             (96 )             -
Other unallocated, net                    1,875           1,639           1,501
Total cost of sales                   $ (51,445 )     $ (46,488 )     $ (43,589 )


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.
Product Costs
Product costs increased approximately $4.3 billion, or 11%, in 2019 as compared
to 2018, primarily due to higher product costs of approximately $1.9 billion at
Aeronautics, $1.3 billion at MFC and $750 million at Space. The increase in
product costs at Aeronautics was primarily due to higher production volume for
the F-35 program and higher volume on classified programs. The increase in
product costs at MFC was primarily due to increased volume for tactical and
strike missile programs (primarily precision fires, classified programs and new
hypersonic missile programs), contract mix and increased volume for integrated
air and missile defense programs (primarily PAC-3 and THAAD) and increased
volume for sensors and global sustainment programs (primarily Apache). The
increase in product costs at Space was primarily attributable to higher volume
for government satellite programs (primarily Next Gen OPIR and GPS III) and
strategic and missile defense programs (primarily new hypersonic development
programs).
Service Costs
Service costs increased approximately $1.0 billion, or 13%, in 2019 compared to
2018, primarily due to higher service costs of approximately $385 million at
RMS, $315 million at Aeronautics and $195 million at MFC. The increase in
service costs at RMS was primarily due to increased volume for various training
and logistics solutions programs and IWSS programs (primarily Aegis). Higher
service costs at Aeronautics were primarily due to higher sustainment volume for
the F-35 and F-22 programs. The increase in service costs at MFC was primarily
attributable to increased volume for sensors and global sustainment programs
(primarily SOF GLSS) and higher sustainment volume for the PAC-3 program.
Restructuring Charges
During 2018, we recorded charges totaling $96 million ($76 million, or $0.26 per
share, after-tax) related to certain severance and restructuring actions at our
RMS business segment. As of December 31, 2019, we have paid substantially all of
the severance payments associated with these actions. In addition, we have
recovered a significant portion of these payments through the pricing of our
products and services to the U.S. Government and other customers, which are
included in RMS' operating results.
Other Unallocated, Net
Other unallocated, net primarily includes the FAS/CAS operating 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 the cost of
sales for products and services. Other unallocated, net was a net reduction to
expense of $1.9 billion in 2019 and $1.6 billion in 2018.
The increase in net reduction in expense from 2019 to 2018 was primarily
attributable to fluctuations in the FAS/CAS operating adjustment of $2.0 billion
in 2019 and $1.8 billion in 2018, and fluctuations in other costs associated
with various corporate items,

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none of which were individually significant. See "Business Segment Results of
Operations" and "Critical Accounting Policies - Postretirement Benefit Plans"
discussion below for more information on our pension cost.
Other Income, Net
Other income, net primarily includes our share of earnings or losses from equity
method investees and gains or losses for acquisitions and divestitures. Other
income, net in 2019 was $178 million, compared to $60 million in 2018. The
increase in 2019 compared to 2018 was primarily attributable to the recognition
in 2019 of a previously deferred non-cash gain of approximately $51 million
($38 million, or $0.13 per share, after-tax) related to properties sold in 2015
as a result of completing our remaining obligations, the recognition in 2019 of
a $34 million gain (approximately $0 after-tax) for the sale of our Distributed
Energy Solutions business, and the recognition in 2018 of a non-cash asset
impairment charge of $110 million ($83 million, or $0.29 per share, after-tax)
related to our equity method investee, Advanced Military Maintenance, Repair and
Overhaul Center LLC (AMMROC). These increases were partially offset by lower
earnings generated by equity method investees.
As of December 31, 2019, our equity method investment in AMMROC totaled
approximately $435 million. We are continuing to monitor this investment in
light of ongoing performance, business base and economic issues, and we may have
to record our portion of additional charges, or an impairment of our investment,
or both, should the carrying value of our investment exceed its fair value.
Substantially all of AMMROC's current business is dependent on one contract that
is currently up for re-competition and if AMMROC is not successful in securing
such business on favorable terms or at all, the carrying value of our investment
would be adversely affected. These charges could adversely affect our results of
operations.
Interest Expense
Interest expense in 2019 was $653 million, compared to $668 million in 2018. The
decrease in interest expense in 2019 resulted primarily from our scheduled
repayment of $750 million of debt during 2018. See "Capital Structure, Resources
and Other" included within "Liquidity and Cash Flows" discussion below and
"Note 10 - Debt" included in our Notes to Consolidated Financial Statements for
a discussion of our debt.
Other Non-Operating Expense, Net
Other non-operating expense, net primarily includes the non-service cost
components of FAS pension and other postretirement benefit plan expense (i.e.,
interest cost, expected return on plan assets, net actuarial gains or losses,
and amortization of prior service cost or credits). Other non-operating expense,
net in 2019 decreased compared to 2018 primarily due to a reduction in
non-service FAS pension expense for our qualified defined benefit pension plans.
Income Tax Expense
Our effective income tax rate from continuing operations was 14.0% for 2019 and
13.6% for 2018. On December 22, 2017, the President signed the Tax Cuts and Jobs
Act (the "Tax Act"). The Tax Act, among other things, lowered the U.S. corporate
income tax rate from 35% to 21% effective January 1, 2018.
We recognized a tax benefit of $220 million in 2019 and $61 million in 2018
related to the deduction for foreign derived intangible income enacted by the
Tax Act, which reduced our effective income tax rate by 3.0 percentage points
and 1.0 percentage points, respectively. The rate for 2019 benefited from $98
million in additional tax deductions for the prior year, primarily due to
proposed tax regulations released on March 4, 2019. We also recognized a tax
benefit of $15 million in 2019 and $61 million in 2018, which reduced our
effective income tax rate by 0.2 and 1.0 percentage points respectively, from
our change in a tax accounting method reflecting a 2012 Court of Federal Claims
decision, which held that the tax basis in certain assets should be increased
and realized upon the assets' disposition.

The rates for 2019 and 2018 benefited from tax deductions for dividends paid to
our defined contribution plans with an employee stock ownership plan feature,
and the U.S. research and development (R&D) tax credit. The R&D tax credit
reduced our effective tax rate by 2.0 percentage points in 2019 and
2.4 percentage points in 2018.
In addition, the rates for 2019 and 2018 benefited from tax benefits related to
employee share-based payment awards, which are recorded in earnings as income
tax benefit or expense. Accordingly, we recognized additional income tax
benefits of $63 million, and $55 million during the years ended December 31,
2019 and 2018, which reduced our effective income tax rate by 0.9 percentage
points for both 2019 and 2018.
Changes in U.S. federal or foreign tax laws and regulations, or their
interpretation and application, including those with retroactive effect,
including the amortization for research or experimental expenditures, could
significantly impact our provision for income taxes, the amount of taxes
payable, our deferred tax asset and liability balances, and stockholders'
equity. The amount

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of net deferred tax assets will change periodically based on several factors,
including the measurement of our postretirement benefit plan obligations, actual
cash contributions to our postretirement benefit plans, and future changes in
tax laws. In addition, we are regularly under audit or examination by tax
authorities, including foreign tax authorities. The final determination of tax
audits and any related litigation could similarly result in unanticipated
increases in our tax expense and affect profitability and cash flows.
Net Earnings
We reported net earnings of $6.2 billion ($21.95 per share) in 2019 and
$5.0 billion ($17.59 per share) in 2018. 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 1 million common shares
outstanding from December 31, 2018 to December 31, 2019 as a result of share
repurchases, partially offset by share issuances under our stock-based awards
and certain defined contribution plans.
Business Segment Results of Operations
We operate in four business segments: Aeronautics, MFC, RMS and Space. We
organize our business segments based on the nature of products and services
offered.
Net sales and operating profit of our business segments exclude intersegment
sales, cost of sales, and profit as these activities are eliminated in
consolidation. Business segment operating profit includes our share of earnings
or losses from equity method investees as the operating activities of the equity
method investees are closely aligned with the operations of our business
segments. United Launch Alliance (ULA), results of which are included in our
Space business segment, is one of our largest equity method investees.
Business segment operating profit also excludes the FAS/CAS operating adjustment
described below, a portion of corporate costs not considered allowable or
allocable to contracts under CAS or federal acquisition regulations (FAR), and
other items not considered part of management's evaluation of segment operating
performance such as a portion of management and administration costs, legal fees
and settlements, environmental costs, stock-based compensation expense, retiree
benefits, significant severance and restructuring actions (see "Note 15 -
Severance and Restructuring Charges" included in our Notes to Consolidated
Financial Statements), gains or losses from significant divestitures, and other
miscellaneous corporate activities.
Excluded items are included in the reconciling item "Unallocated items" between
operating profit from our business segments and our consolidated operating
profit. See "Note 1 - Significant Accounting Policies" included in our Notes to
Consolidated Financial Statements for a discussion related to certain factors
that may impact the comparability of net sales and operating profit of our
business segments.
Our business segments' results of operations include pension expense only as
calculated under CAS pension cost. We recover CAS pension and other
postretirement benefit plan cost through the pricing of our products and
services on U.S. Government contracts and, therefore, recognize CAS cost in each
of our business segment's net sales and cost of sales. Our consolidated
financial statements must present FAS pension and other postretirement benefit
plan expense calculated in accordance with FAS requirements under U.S. GAAP. The
operating portion of the net FAS/CAS pension adjustment represents the
difference between the service cost component of FAS pension expense and total
CAS pension cost. The non-service FAS pension cost component is included in
other non-operating expense, net in our consolidated statements of earnings. As
a result, to the extent that CAS pension cost exceeds the service cost component
of FAS pension expense, which occurred for 2019 and 2018, we have a favorable
FAS/CAS operating adjustment.

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Summary operating results for each of our business segments were as follows (in
millions):
                                              2019         2018         2017
Net sales
Aeronautics                               $ 23,693     $ 21,242     $ 19,410
Missiles and Fire Control                   10,131        8,462        7,282
Rotary and Mission Systems                  15,128       14,250       13,663
Space                                       10,860        9,808        9,605
Total net sales                           $ 59,812     $ 53,762     $ 49,960
Operating profit
Aeronautics                               $  2,521     $  2,272     $  2,176
Missiles and Fire Control                    1,441        1,248        1,034
Rotary and Mission Systems                   1,421        1,302          902
Space                                        1,191        1,055          980
Total business segment operating profit      6,574        5,877        5,092
Unallocated items
FAS/CAS operating adjustment (a)             2,049        1,803        

1,613

Stock-based compensation                      (189 )       (173 )       (158 )
Severance and restructuring charges (b)          -          (96 )          -
Other, net (c)                                 111          (77 )        197
Total unallocated, net                       1,971        1,457        1,652

Total consolidated operating profit $ 8,545 $ 7,334 $ 6,744

(a) The FAS/CAS operating adjustment represents the difference between the

service cost component of FAS pension expense and total pension costs

recoverable on U.S. Government contracts as determined in accordance with

CAS. For a detail of the FAS/CAS operating adjustment and the total net

FAS/CAS pension adjustment, see the table below.

(b) See "Consolidated Results of Operations - Restructuring Charges" discussion

above for information on charges related to certain severance actions at our

business segments. Severance and restructuring charges for initiatives that

     are not significant are included in business segment operating profit.

(c) Other, net in 2019 includes a previously deferred non-cash gain of

$51 million related to properties sold in 2015 as a result of completing our

remaining obligations and a gain of $34 million for the sale of our

Distributed Energy Solutions business. Other, net in 2018 includes a

non-cash asset impairment charge of $110 million related to our equity

method investee, AMMROC (see "Note 1 - Significant Accounting Policies"

included in our Notes to Consolidated Financial Statements for more

information). Other, net in 2017 includes a previously deferred non-cash

     gain of $198 million related to properties sold in 2015 as a result of
     completing our remaining obligations and a $64 million charge, which
     represents our portion of a non-cash asset impairment charge recorded by

AMMROC (see "Note 1 - Significant Accounting Policies" included in our Notes

to Consolidated Financial Statements for more information).

Total net FAS/CAS pension adjustments, including the service and non-service cost components of FAS pension expense, were as follows (in millions):

                                                  2019         2018         

2017

Total FAS expense and CAS costs
FAS pension expense                           $ (1,093 )   $ (1,431 )   $ (1,372 )
Less: CAS pension cost                           2,565        2,433        

2,248

Net FAS/CAS pension adjustment                $  1,472     $  1,002     $   

876

Service and non-service cost reconciliation
FAS pension service cost                          (516 )       (630 )       (635 )
Less: CAS pension cost                           2,565        2,433        2,248
FAS/CAS operating adjustment                     2,049        1,803        1,613
Non-operating FAS pension expense (a)             (577 )       (801 )       (737 )
Net FAS/CAS pension adjustment                $  1,472     $  1,002     $   

876

(a) We record the non-service cost components of net periodic benefit cost as

part of other non-operating expense, net in the consolidated statement of

earnings. The non-service cost components in the table above relate only to

our qualified defined benefit pension plans. We incurred total non-service

costs for our qualified defined benefit pension plans in the table above,

along with similar costs for our other postretirement benefit plans of $116

million, $67 million, and $109 million for the years ended 2019, 2018 and

     2017.



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We recover CAS pension and other postretirement benefit plan cost through the
pricing of our products and services on U.S. Government contracts and,
therefore, recognize CAS cost in each of our business segment's net sales and
cost of sales. Our consolidated financial statements must present FAS pension
and other postretirement benefit plan expense calculated in accordance with FAS
requirements under U.S. GAAP. The operating portion of the net FAS/CAS pension
adjustment represents the difference between the service cost component of FAS
pension expense and total CAS pension cost. The non-service FAS pension cost
component is included in other non-operating expense, net in our consolidated
statements of earnings. The net FAS/CAS pension adjustment increases or
decreases CAS pension cost to equal total FAS pension expense (both service and
non-service).
The following segment discussions also include information relating to backlog
for each segment. Backlog was approximately $144.0 billion and $130.5 billion at
December 31, 2019 and 2018. These amounts included both funded backlog (firm
orders for which funding has been both authorized and appropriated by the
customer) and unfunded backlog (firm orders for which funding has not yet been
appropriated). Backlog does not include unexercised options or task orders to be
issued under indefinite-delivery, indefinite-quantity contracts. Funded backlog
was approximately $94.5 billion at December 31, 2019.
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.
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 aircraft sustainment). Our contracts
generally allow 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 recovery of our actual costs plus
a reasonable profit margin. 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, sometimes referred to as offset agreements, required
under certain contracts with international customers). The initial profit
booking rate of each contract considers risks surrounding the ability to achieve
the technical requirements, schedule and costs in the initial estimated total
costs to complete the contract. Profit booking rates may increase during the
performance of the contract if we successfully retire risks surrounding the
technical, schedule and cost aspects of the contract, which decreases the
estimated total costs to complete the contract. Conversely, our profit booking
rates may decrease if the estimated total costs to complete the contract
increase. All of the estimates are subject to change during the performance of
the contract and may affect the profit booking rate.
We have a number of programs that are designated as classified by the U.S.
Government which cannot be specifically described. The operating results of
these classified programs are included in our consolidated and business segment
results and are subjected to the same oversight and internal controls as our
other programs.
Our net sales are primarily derived from long-term contracts for products and
services provided to the U.S. Government as well as FMS contracted through the
U.S. Government. We recognize revenue as performance obligations are satisfied
and the customer obtains control of the products and services. For performance
obligations to deliver products with continuous transfer of control to the
customer, revenue is recognized based on the extent of progress towards
completion of the performance obligation, generally using the
percentage-of-completion cost-to-cost measure of progress for our contracts
because it best depicts the transfer of control to the customer as we incur
costs on our contracts. For performance obligations in which control does not
continuously transfer to the customer, we recognize revenue at the point in time
in which each performance obligation is fully satisfied.
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.

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In addition, comparability of our segment sales, operating profit and operating
margin may be impacted favorably or unfavorably by changes in profit booking
rates on our contracts for which we recognize revenue over time using the
percentage-of-completion cost-to-cost method to measure progress towards
completion. Increases in the profit booking rates, typically referred to as risk
retirements, usually relate to revisions in the estimated total costs to fulfill
the performance obligations that reflect improved conditions on a particular
contract. Conversely, conditions on a particular contract may deteriorate,
resulting in an increase in the estimated total costs to fulfill the performance
obligations and a reduction in the profit booking rate. Increases or decreases
in profit booking rates are recognized in the current period and reflect the
inception-to-date effect of such changes. Segment operating profit and margin
may also be impacted favorably or unfavorably by other items, which may or may
not impact sales. Favorable items may include the positive resolution of
contractual matters, cost recoveries on severance and restructuring charges,
insurance recoveries and gains on sales of assets. Unfavorable items may include
the adverse resolution of contractual matters; restructuring charges, except for
significant severance actions, which are excluded from segment operating
results; reserves for disputes; certain asset impairments; and losses on sales
of certain assets. Segment operating profit and items such as risk retirements,
reductions of profit booking rates or other matters are presented net of state
income taxes.
As previously disclosed, we are responsible for a program to design, develop and
construct a ground-based radar at our RMS business segment. The program has
experienced performance issues for which we have periodically accrued reserves.
In 2019, we revised our estimated costs to complete the program and recorded a
charge of approximately $60 million ($47 million, or $0.17 per share, after-tax)
at our RMS business segment, which resulted in cumulative losses of
approximately $205 million on this program as of December 31, 2019. We may
continue to experience issues related to customer requirements and our
performance under this contract and have to record additional charges. However,
based on the losses previously recorded and our current estimate of the sales
and costs to complete the program, at this time we do not anticipate that
additional losses, if any, would be material to our operating results or
financial condition.
As previously disclosed, we have a program, EADGE-T, to design, integrate, and
install an air missile defense command, control, communications, computers -
intelligence (C4I) system for an international customer that has experienced
performance issues and for which we have periodically accrued reserves. In 2017,
we revised our estimated costs to complete the EADGE-T contract as a consequence
of ongoing performance matters and recorded an additional charge of $120 million
($74 million, or $0.25 per share, after-tax) at our Rotary and Mission Systems
(RMS) business segment, which resulted in cumulative losses of approximately
$260 million on this program. As of December 31, 2019, cumulative losses
remained at approximately $260 million. We continue to monitor program
requirements and our performance. At this time, we do not anticipate additional
charges that would be material to our operating results or financial condition.
As previously disclosed, we have two commercial satellite programs at our Space
business segment for which we have experienced performance issues related to the
development and integration of a modernized LM 2100 satellite platform. These
programs are for the delivery of three satellites in total, including one that
launched in February 2019 and one that launched in April 2019. We have
periodically revised our estimated costs to complete these developmental
commercial programs. As of December 31, 2019, cumulative losses remained at
approximately $410 million for these programs. While these losses reflect our
estimated total losses on the programs, we will continue to incur unrecoverable
general and administrative costs each period until we complete the contract for
the third satellite. We have launched two satellites from one program, and the
third satellite has completed development and has been shipped to the launch
site for a planned launch in the first quarter of 2020.  Any new satellite
anomalies discovered during launch preparation requiring repair or rework, or
prolonged on orbit testing prior to customer handover, could require that we
record additional loss reserves, which could be material to our operating
results.
As previously disclosed, we are responsible for designing, developing and
installing an upgraded turret for the Warrior Capability Sustainment Program. In
2018, we revised our estimated costs to complete the program as a consequence of
performance issues, and recorded a charge of approximately $85 million
($64 million, or $0.22 per share, after-tax) at our MFC business segment, which
resulted in cumulative losses of approximately $140 million on this program at
December 31, 2019. We may continue to experience issues related to customer
requirements and our performance under this contract and have to record
additional reserves. However, based on the losses already recorded and our
current estimate of the sales and costs to complete the program, at this time we
do not anticipate that additional losses, if any, would be material to our
operating results or financial condition.
Our consolidated net adjustments not related to volume, including net profit
booking rate adjustments and other items, net of state income taxes, increased
segment operating profit by approximately $1.9 billion in both 2019 and 2018.
The consolidated net adjustments in 2019 compared to 2018 were comparable
primarily due to an increase in profit booking rate adjustments at Space offset
by decreases in the other three business segments. The consolidated net
adjustments for 2019 are inclusive of approximately $930 million in unfavorable
items, which include reserves for various programs at RMS, the F-16 program at
Aeronautics, performance matters on a sensors and global sustainment
international military program at MFC and government satellite programs at
Space. The consolidated net adjustments for 2018 are inclusive of approximately
$900 million in unfavorable items, which

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include reserves for performance matters on the Warrior Capability Sustainment
Program at MFC, various programs at RMS, and commercial satellite programs at
Space.
Aeronautics
Our Aeronautics business segment is engaged in the research, design,
development, manufacture, integration, sustainment, support and upgrade of
advanced military aircraft, including combat and air mobility aircraft, unmanned
air vehicles and related technologies. Aeronautics' major programs include the
F-35 Lightning II Joint Strike Fighter, C­130 Hercules, F-16 Fighting Falcon and
F-22 Raptor. Aeronautics' operating results included the following (in
millions):
                          2019          2018          2017
Net sales             $ 23,693      $ 21,242      $ 19,410
Operating profit         2,521         2,272         2,176
Operating margin          10.6  %       10.7  %       11.2  %
Backlog at year-end   $ 55,636      $ 55,601      $ 35,692


Aeronautics' net sales in 2019 increased $2.5 billion, or 12%, compared to 2018.
The increase was primarily attributable to higher net sales of approximately
$2.0 billion for the F-35 program due to increased volume on production,
sustainment and development contracts; and about $350 million for higher volume
on classified programs.
Aeronautics' operating profit in 2019 increased $249 million, or 11%, compared
to 2018. Operating profit increased approximately $210 million for the
F-35 program due to increased volume on production, sustainment and development
contracts; and about $50 million for the F-16 program due to higher risk
retirements on sustainment contracts. These increases were partially offset by a
decrease of $20 million on the F-22 program due to lower risk retirements.
Adjustments not related to volume, including net profit booking rate
adjustments, were $25 million lower in 2019 compared to 2018.
Backlog
Backlog in 2019 was comparable to 2018.
Trends
We expect Aeronautics' 2020 net sales to increase in the high-single digit
percentage range from 2019 levels driven by increased volume on the F-35
program. Operating profit is also expected to increase in the high-single digit
percentage range above 2019 levels. Operating profit margin for 2020 is expected
to be slightly higher than 2019 levels.
Missiles and Fire Control
Our MFC business segment provides air and missile defense systems; tactical
missiles and air-to-ground precision strike weapon systems; logistics; fire
control systems; mission operations support, readiness, engineering support and
integration services; manned and unmanned ground vehicles; and energy management
solutions. MFC's major programs include PAC­3, THAAD, Multiple Launch Rocket
System (MLRS), Hellfire, Joint Air-to-Surface Standoff Missile (JASSM), Javelin,
Apache, SNIPER®, LANTIRN and SOF GLSS. MFC's operating results included the
following (in millions):
                          2019          2018          2017
Net sales             $ 10,131      $  8,462      $  7,282
Operating profit         1,441         1,248         1,034
Operating margin          14.2  %       14.7  %       14.2  %
Backlog at year-end   $ 25,796      $ 21,363      $ 17,729


MFC's net sales in 2019 increased $1.7 billion, or 20%, compared to the same
period in 2018. The increase was primarily attributable to higher net sales of
approximately $940 million for tactical and strike missile programs due to
increased volume (primarily precision fires, new hypersonic development
programs, and classified development programs); about $465 million for
integrated air and missile defense programs due to increased volume (primarily
PAC-3 and THAAD); and about $300 million for sensors and global sustainment
programs due to increased volume (primarily SOF GLSS and Apache).
MFC's operating profit in 2019 increased $193 million, or 15%, compared to 2018.
Operating profit increased approximately $100 million for integrated air and
missile defense programs due to higher volume and higher risk retirements
(primarily PAC-3 and THAAD); and about $60 million for tactical and strike
missile programs due to higher volume (primarily precision fires),

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partially offset by lower risk retirements (primarily Hellfire and Javelin).
Operating profit on sensors and global sustainment programs was comparable as
higher volume (primarily Apache and SOF GLSS) was offset by lower risk
retirements (primarily LANTIRN and SNIPER), after a net decrease in charges of
$55 million on international military programs. Adjustments not related to
volume, including net profit booking rate adjustments, were $30 million lower in
2019 compared to 2018.
Backlog
Backlog increased in 2019 compared to 2018 primarily due to higher orders on
THAAD, PAC-3 and precision fires programs.
Trends
We expect MFC's 2020 net sales to increase in the low-double digit percentage
range in 2020 as compared to 2019 driven by higher volume in the tactical and
strike missiles and air and missile defense businesses, partially offset by a
decrease in sales as a result of the divestiture of our Distributed Energy
Solutions business. Operating profit is expected to increase in the mid-single
digit percentage range in 2020 as compared to 2019 driven by the increase in
sales volume. Operating profit margin for 2020 is expected to be slightly lower
than 2019 levels.

Rotary and Mission Systems
Our RMS business segment provides design, manufacture, service and support for a
variety of military and commercial helicopters; ship and submarine mission and
combat systems; mission systems and sensors for rotary and fixed-wing aircraft;
sea and land-based missile defense systems; radar systems; the Littoral Combat
Ship (LCS); simulation and training services; and unmanned systems and
technologies. In addition, RMS supports the needs of government customers in
cybersecurity and delivers communication and command and control capabilities
through complex mission solutions for defense applications. RMS' major programs
include Black Hawk and Seahawk helicopters, Aegis, CH-53K King Stallion
helicopter, LCS, VH-92A helicopter program, and the C2BMC contract. RMS'
operating results included the following (in millions):
                          2019          2018          2017
Net sales             $ 15,128      $ 14,250      $ 13,663
Operating profit         1,421         1,302           902
Operating margin           9.4  %        9.1  %        6.6  %
Backlog at year-end   $ 34,296      $ 31,320      $ 30,030


RMS' net sales in 2019 increased $878 million, or 6%, compared to 2018. The
increase was primarily attributable to higher net sales of approximately
$535 million for IWSS programs due to higher volume (primarily LCS, radar
surveillance systems programs, Multi Mission Surface Combatant (MMSC), and
Aegis); about $290 million for various training and logistics (TLS) programs due
to higher volume (primarily an army sustainment program); and about $200 million
for various C6ISR (command, control, communications, computers, cyber, combat
systems, intelligence, surveillance, and reconnaissance) programs due to higher
volume (primarily undersea combat systems and cyber solutions programs). These
increases were partially offset by a decrease of approximately $145 million for
Sikorsky helicopter programs due to lower volume (primarily Black Hawk
production, mission systems programs, and commercial aircraft).
RMS' operating profit in 2019 increased $119 million, or 9%, compared to 2018.
Operating profit increased approximately $105 million for Sikorsky helicopter
programs primarily due to better cost performance across the portfolio, customer
mix, and higher risk retirements; and about $55 million for IWSS programs due to
higher volume (primarily radar surveillance systems programs, LCS, and Aegis),
after $50 million in charges in the first quarter of 2019 for a ground-based
radar program. These increases were partially offset by a decrease of $50
million for TLS programs due to $80 million in charges primarily recorded in the
second quarter of 2019 for an army sustainment program partially offset by lower
charges on various other programs. Adjustments not related to volume, including
net profit booking rate adjustments, were $65 million lower in 2019 compared to
2018.
Backlog
Backlog increased in 2019 compared to 2018 primarily due to higher orders on
IWSS programs.
Trends
We expect RMS' 2020 net sales to increase in the mid-single digit range above
2019 levels driven primarily by Sikorsky. Operating profit is also expected to
increase in the mid-single digit range above 2019 levels driven by the increase
in sales

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volume. Operating profit margin for 2020 is expected to be slightly higher than
2019 levels.
Space
Our Space business segment is engaged in the research and development, design,
engineering and production of satellites, strategic and defensive missile
systems and space transportation systems. Space provides network-enabled
situational awareness and integrates complex space and ground-based global
systems to help our customers gather, analyze, and securely distribute critical
intelligence data. Space is also responsible for various classified systems and
services in support of vital national security systems. Space's major programs
include the Trident II D5 Fleet Ballistic Missile (FBM), AWE, Orion
Multi-Purpose Crew Vehicle (Orion), Space Based Infrared System (SBIRS) and Next
Generation Overhead Persistent Infrared (Next Gen OPIR) system, Global
Positioning System (GPS) III, Advanced Extremely High Frequency (AEHF), and
hypersonics. Operating profit for our Space business segment includes our share
of earnings for our investment in ULA, which provides expendable launch services
to the U.S. Government. Space's operating results included the following (in
millions):
                          2019          2018          2017
Net sales             $ 10,860      $  9,808      $  9,605
Operating profit         1,191         1,055           980

Operating margin 11.0 % 10.8 % 10.2 % Backlog at year-end $ 28,253 $ 22,184 $ 22,042

Space's net sales in 2019 increased $1.1 billion, or 11%, compared to 2018. The
increase was primarily attributable to higher net sales of approximately $690
million for government satellite programs due to higher volume (primarily Next
Gen OPIR, GPS III and government satellite services); and about $355 million for
strategic and missile defense programs due to higher volume (primarily new
hypersonic development programs).
Space's operating profit in 2019 increased $136 million, or 13%, compared to
2018. Operating profit increased approximately $125 million for government
satellite programs due to higher risk retirements (primarily AEHF) and higher
volume (primarily GPS III and government satellite services); and about $45
million for commercial satellite programs, which reflect a lower amount of
charges recorded for performance matters. These increases were partially offset
by a decrease of approximately $65 million due to lower equity earnings for ULA.
Operating profit on strategic and missile defense programs was comparable as
higher volume (primarily hypersonic development programs) was offset by lower
risk retirements (primarily missile defense programs). Adjustments not related
to volume, including net profit booking rate adjustments, were $120 million
higher in 2019 compared to 2018.
Equity earnings
Total equity earnings recognized by Space (primarily ULA) represented
approximately $145 million and $210 million, or 12% and 20% of this business
segment's operating profit during 2019 and 2018.
Backlog
Backlog increased in 2019 compared to 2018 primarily due to new orders in
strategic and missile defense (hypersonic development programs and AWE) and
space transportation (Orion).
Trends
We expect Space's 2020 net sales to increase in the mid-single digit percentage
range from 2019 levels largely driven by hypersonics. Operating profit in 2020
is expected to decrease in the mid-single digit percentage range as compared to
2019 driven by lower profit rate adjustments in government satellites and lower
equity earnings in 2020 compared to 2019. As a result, operating profit margin
in 2020 is expected to decrease from 2019 levels.
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 continued to invest in our
business, including capital expenditures, independent research and development,
and selective business acquisitions and investments; returned cash to
stockholders through dividends and share repurchases; and actively managed our
debt levels and maturities, interest rates, and pension obligations.

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We have generated strong operating cash flows, which have been the primary
source of funding for our operations, capital expenditures, debt service and
repayments, dividends, share repurchases and postretirement benefit plan
contributions. Our strong operating cash flows enabled our Board of Directors to
approve two key cash deployment initiatives in September 2019. First, we
increased our dividend rate in the fourth quarter by $0.20 to $2.40 per share.
Second, the Board of Directors approved a $1.0 billion increase to our share
repurchase program. Inclusive of this increase, the total remaining
authorization for future common share repurchases under our program was $2.8
billion as of December 31, 2019.
We expect our cash from operations will continue to be sufficient to support our
operations and anticipated capital expenditures for the foreseeable future. We
also have access to credit markets, if needed, for liquidity or general
corporate purposes, and letters of credit to support customer advance payments
and for other trade finance purposes such as guaranteeing our performance on
particular contracts. See our "Capital Structure, Resources and Other" section
below for a discussion on financial resources available to us, including the
issuance of commercial paper.
We made discretionary contributions of $1.0 billion to our qualified defined
benefit pension plans in 2019 using cash on hand. We made contributions of $5.0
billion to our qualified defined benefit pension plans in 2018, including
required and discretionary contributions. We do not expect to make contributions
to our qualified defined benefit pension plans in 2020.
Cash received from customers, either from the payment of invoices for work
performed or for advances from non-U.S. Government customers in excess of costs
incurred, is our primary source of cash. We generally do not begin work on
contracts until funding is appropriated by the customer. However, we may
determine to fund customer programs ourselves pending government appropriations.
If we incur costs in excess of funds obligated on the contract, we may be at
risk for reimbursement of the excess costs.
Billing timetables and payment terms on our contracts vary based on a number of
factors, including the contract type. We generally bill and collect cash more
frequently under cost-reimbursable contracts, which represented approximately
39% of the sales we recorded in 2019, as we are authorized to bill as the costs
are incurred. A number of our fixed-price contracts may provide for
performance-based payments, which allow us to bill and collect cash as we
perform on the contract. The amount of performance-based payments and the
related milestones are encompassed in the negotiation of each contract. The
timing of such payments may differ from our incurrence of costs related to our
contract performance, thereby affecting our cash flows.
The U.S. Government has indicated that it would consider progress payments as
the baseline for negotiating payment terms on fixed-price contracts, rather than
performance-based payments. In contrast to negotiated performance-based payment
terms, progress payment provisions correspond to a percentage of the amount of
costs incurred during the performance of the contract. Our cash flows may be
affected if the U.S. Government decides to withhold payments on our billings.
While the impact of withholding payments delays the receipt of cash, the
cumulative amount of cash collected during the life of the contract will not
vary.
The majority of our capital expenditures for 2019 and those planned for 2020 are
for equipment, facilities infrastructure and information technology.
Expenditures for equipment and facilities infrastructure are generally incurred
to support new and existing programs across all of our business segments. For
example, we have projects underway in our Aeronautics business segment for
facilities and equipment to support higher production of the F-35 combat
aircraft, and we have projects underway to modernize certain of our facilities.
We also incur capital expenditures for information technology to support
programs and general enterprise information technology infrastructure, inclusive
of costs for the development or purchase of internal-use software.

The following table provides a summary of our cash flow information followed by a discussion of the key elements (in millions):

                                                    2019        2018        

2017

Cash and cash equivalents at beginning of year   $   772     $ 2,861     $ 1,837
Operating activities
Net earnings                                       6,230       5,046       1,963
Non-cash adjustments                               1,549       1,186       4,530
Changes in working capital                          (672 )    (1,401 )      (427 )
Other, net                                           204      (1,693 )       410

Net cash provided by operating activities 7,311 3,138 6,476 Net cash used for investing activities

            (1,241 )    (1,075 )    (1,147 )
Net cash used for financing activities            (5,328 )    (4,152 )    (4,305 )
Net change in cash and cash equivalents              742      (2,089 )     

1,024

Cash and cash equivalents at end of year $ 1,514 $ 772 $ 2,861

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Operating Activities
Net cash provided by operating activities increased $4.2 billion in 2019
compared to 2018 primarily due to a reduction in cash contributions made to our
qualified defined benefit pension plans and an improvement in cash used for
working capital, partially offset by an increase in cash paid for income taxes.
During 2019, we made cash contributions to our qualified defined benefit pension
plans of $1.0 billion compared to $5.0 billion in 2018. The $729 million
improvement in cash flows used for working capital (defined as receivables,
contract assets, and inventories less accounts payable and contract liabilities)
was primarily attributable to timing of production and billing cycles affecting
contract assets (primarily the F-35 program) and contract liabilities (primarily
C-130 program at Aeronautics and IWSS programs at RMS), partially offset by the
timing of cash payments for accounts payable (primarily Aeronautics) and growth
in inventories (primarily classified programs at Aeronautics and Sikorsky at
RMS). We made net cash tax payments of approximately $940 million in 2019
compared to receiving net tax refunds of approximately $41 million in 2018.
Investing Activities
Net cash used for investing activities increased $166 million in 2019 compared
to 2018, primarily due to an increase in capital expenditures, partially offset
by net cash proceeds from various divestitures and acquisitions, and cash
received for various other items, none of which were individually significant.
Capital expenditures totaled $1.5 billion in 2019 and $1.3 billion in 2018. 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 the development or purchase of
internal-use software.
Financing Activities
Net cash used for financing activities increased $1.2 billion in 2019 compared
to 2018, primarily driven by net repayments of $600 million for commercial paper
in 2019 compared to net proceeds received of $600 million of commercial paper in
2018.
In November 2019, we repaid $900 million of long-term notes with a fixed
interest rate of 4.25% according to their scheduled maturities. In November
2018, we repaid $750 million of long-term notes with a fixed interest rate of
1.85% according to their scheduled maturities.
For additional information about our debt financing activities see the "Capital
Structure, Resources and Other" discussion below and "Note 10 - Debt" included
in our Notes to Consolidated Financial Statements.
We paid dividends totaling $2.6 billion ($9.00 per share) in 2019 and
$2.3 billion ($8.20 per share) in 2018.We paid quarterly dividends of $2.20 per
share during each of the first three quarters of 2019 and $2.40 per share during
the fourth quarter of 2019. We paid quarterly dividends of $2.00 per share
during each of the first three quarters of 2018 and $2.20 per share during the
fourth quarter of 2018.
We paid $1.2 billion to repurchase 3.5 million shares of our common stock during
2019, which includes the $350 million paid to repurchase 916,249 shares pursuant
to the accelerated share repurchase (ASR) agreement entered into during the
fourth quarter. We paid $1.5 billion to repurchase 4.7 million shares of our
common stock during 2018. See "Note 12 - Stockholders' Equity" included in our
Notes to Consolidated Financial Statements for additional information about our
repurchases of common stock.
Capital Structure, Resources and Other
At December 31, 2019, we held cash and cash equivalents of $1.5 billion that was
generally available to fund ordinary business operations without significant
legal, regulatory, or other restrictions.
Our outstanding debt, net of unamortized discounts and issuance costs, amounted
to $12.7 billion at December 31, 2019 and mainly is in the form of
publicly-issued notes that bear interest at fixed rates. As of December 31,
2019, we had $1.3 billion of short-term borrowings due within one year, which
are scheduled to mature in November 2020. As of December 31, 2018, we had $1.5
billion of short-term borrowings due within one year, of which $900 million was
composed of a scheduled debt maturity due in November 2019 and $600 million was
composed of commercial paper with a weighted-average rate of 2.89% outstanding,
all of which were repaid during 2019. As of December 31, 2019, we were in
compliance with all covenants contained in our debt and credit agreements.
We actively seek to finance our business in a manner that preserves financial
flexibility while minimizing borrowing costs to the extent practicable. We
review changes in financial market and economic conditions to manage the types,
amounts and maturities

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of our indebtedness. We may at times refinance existing indebtedness, vary our
mix of variable-rate and fixed-rate debt or seek alternative financing sources
for our cash and operational needs.
On occasion, our customers may seek deferred payment terms to purchase our
products. In connection with these transactions, we may, at our customer's
request, enter into arrangements for the non-recourse sale of customer
receivables to unrelated third-party financial institutions. For accounting
purposes, these transactions are not discounted and are treated as a sale of
receivables as we have no continuing involvement. The sale proceeds from the
financial institutions are reflected in our operating cash flows on the
statement of cash flows. We sold approximately $387 million in 2019 and
$532 million in 2018 of customer receivables. There were no gains or losses
related to sales of these receivables.
Revolving Credit Facilities
At December 31, 2019, we had a $2.5 billion revolving credit facility (the
5-year Facility) with various banks that is available for general corporate
purposes. Effective August 24, 2019, we extended the expiration date of the
5-year Facility from August 24, 2023 to August 24, 2024. The undrawn portion of
the 5-year Facility also serves as a backup facility for the issuance of
commercial paper. The total amount outstanding at any point in time under the
combination of our commercial paper program and the credit facility cannot
exceed the amount of the 5-year Facility. We may request and the banks may
grant, at their discretion, an increase in the borrowing capacity under the
5-year Facility of up to an additional $500 million. There were no borrowings
outstanding under the 5-year Facility as of December 31, 2019 and 2018.
Borrowings under the 5-year Facility are unsecured and bear interest at rates
based, at our option, on a Eurodollar Rate or a Base Rate, as defined in the
5-year Facility's agreement. Each bank's obligation to make loans under the
5-year Facility is subject to, among other things, our compliance with various
representations, warranties and covenants, including covenants limiting our
ability and certain of our subsidiaries' ability to encumber assets and a
covenant not to exceed a maximum leverage ratio, as defined in the 5­year
Facility agreement.
Long-Term Debt
In November 2019, we repaid $900 million of long-term notes with a fixed
interest rate of 4.25% according to their scheduled maturities. In November
2018, we repaid $750 million of long-term notes with a fixed interest rate of
1.85% according to their scheduled maturities.
In September 2017, we issued notes totaling approximately $1.6 billion with a
fixed interest rate of 4.09% maturing in September 2052 (the New Notes) in
exchange for outstanding notes totaling approximately $1.4 billion with fixed
interest rates ranging from 4.70% to 8.50% maturing 2029 to 2046 (the Old
Notes). In connection with the exchange of principal, we paid a premium of
$237 million, substantially all of which was in the form of New Notes. This
premium will be amortized as additional interest expense over the term of the
New Notes using the effective interest method. We may, at our option, redeem
some or all of the New Notes at any time by paying the principal amount of notes
being redeemed plus a make-whole premium and accrued and unpaid interest.
Interest on the New Notes is payable on March 15 and September 15 of each year
and began on March 15, 2018. The New Notes are unsecured senior obligations and
rank equally in right of payment with all of our existing and future unsecured
and unsubordinated indebtedness.
We 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.
Total Equity
Our total equity was $3.2 billion at December 31, 2019, an increase of
$1.7 billion from December 31, 2018. The increase was primarily attributable to
net earnings of $6.2 billion, recognition of previously deferred postretirement
benefit plan amounts of $908 million, and employee stock activity of
$486 million (including the impacts of stock option exercises, issuances of
shares under the employee stock ownership plan and stock-based compensation),
partially offset by the annual December 31 re-measurement adjustment related to
our postretirement benefit plans of $2.2 billion, the repurchase of 3.5 million
common shares for $1.2 billion; and dividends declared of $2.6 billion during
the year.
As we repurchase our common shares, we reduce common stock for the $1 of par
value of the shares repurchased, with the excess purchase price over par value
recorded as a reduction of additional paid-in capital. If additional paid-in
capital is reduced to zero, we record the remainder of the excess purchase price
over par value as a reduction of retained earnings. Due to the volume of
repurchases made under our share repurchase program, additional paid-in capital
was reduced to zero, with the remainder of the excess purchase price over par
value of $713 million recorded as a reduction of retained earnings in 2019.

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Contractual Commitments and Off-Balance Sheet Arrangements
At December 31, 2019, we had contractual commitments to repay debt, make
payments under operating leases, settle obligations related to agreements to
purchase goods and services and settle tax and other liabilities. Financing
lease obligations were not material. Payments due under these obligations and
commitments are as follows (in millions):
                                                         Payments Due By Period
                                               Less Than        Years           Years          After
                                 Total          1 Year         2 and 3         4 and 5         5 Years
Total debt (a)                $   13,799     $     1,250     $       906     $       786     $     10,857
Interest payments                  9,277             571           1,048             979            6,679
Other liabilities                  2,914             252             567             400            1,695
Operating lease obligations        1,287             280             344             217              446
Purchase obligations:
Operating activities              55,491          28,564          22,528           3,483              916
Capital expenditures                 839             446             309              84                -
Total contractual cash
obligations                   $   83,607     $    31,363     $    25,702

$ 5,949 $ 20,593

(a) Total debt excludes approximately $15 million of debt issued by a

consolidated joint venture as we do not guarantee the debt.

The table above excludes estimated minimum funding requirements for our
qualified defined benefit pension plans. For additional information about our
future minimum contributions for these plans, see "Note 11 - Postretirement
Benefit Plans" included in our Notes to Consolidated Financial Statements.
Amounts related to other liabilities represent the contractual obligations for
certain long-term liabilities recorded as of December 31, 2019. Such amounts
mainly include expected payments under non-qualified pension plans,
environmental liabilities and deferred compensation plans.
Purchase obligations related to operating activities include agreements and
contracts that give the supplier recourse to us for cancellation or
nonperformance under the contract or contain terms that would subject us to
liquidated damages. Such agreements and contracts may, for example, be related
to direct materials, obligations to subcontractors and outsourcing arrangements.
Total purchase obligations for operating activities in the preceding table
include approximately $49.9 billion related to contractual commitments entered
into as a result of contracts we have with our U.S. Government customers. The
U.S. Government generally would be required to pay us for any costs we incur
relative to these commitments if they were to terminate the related contracts
"for convenience" under the FAR, subject to available funding. This also would
be true in cases where we perform subcontract work for a prime contractor under
a U.S. Government contract. The termination for convenience language also may be
included in contracts with foreign, state and local governments. We also have
contracts with customers that do not include termination for convenience
provisions, including contracts with commercial customers.
Purchase obligations in the preceding table for capital expenditures generally
include facilities infrastructure, equipment and information technology.
We also may enter into industrial cooperation agreements, sometimes referred to
as offset agreements, as a condition to obtaining orders for our products and
services from certain customers in foreign countries. These agreements are
designed to enhance the social and economic environment of the foreign country
by requiring the contractor to promote investment in the country. Offset
agreements may be satisfied through activities that do not require us to use
cash, including transferring technology, providing manufacturing and other
consulting support to in-country projects and the purchase by third parties
(e.g., our vendors) of supplies from in-country vendors. These agreements also
may be satisfied through our use of cash for such activities as purchasing
supplies from in-country vendors, providing financial support for in-country
projects, establishment of joint ventures with local companies and building or
leasing facilities for in-country operations. We typically do not commit to
offset agreements until orders for our products or services are definitive. The
amounts ultimately applied against our offset agreements are based on
negotiations with the customer and typically require cash outlays that represent
only a fraction of the original amount in the offset agreement. Satisfaction of
our offset obligations are included in the estimates of our total costs to
complete the contract and may impact our sales, profitability and cash flows.
Our ability to recover investments on our consolidated balance sheet that we
make to satisfy offset obligations is generally dependent upon the successful
operation of ventures that we do not control and may involve products and
services that are dissimilar to our business activities. At December 31, 2019,
the notional value of remaining obligations under our outstanding offset
agreements totaled approximately $15.1 billion, which primarily relate to our
Aeronautics, MFC and RMS business segments, most of which extend through 2049.
To the extent we have entered into purchase or other obligations at December 31,
2019 that also satisfy offset agreements, those amounts are included in the
preceding table. Offset programs usually extend over several years and may
provide for penalties, estimated at approximately $1.9 billion at December 31,
2019, in the

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event we fail to perform in accordance with offset requirements. While
historically we have not been required to pay material penalties, resolution of
offset requirements are often the result of negotiations and subjective
judgments.
We have entered into standby letters of credit and surety bonds issued on our
behalf by financial institutions, and we have directly issued guarantees to
third parties primarily relating to advances received from customers and the
guarantee of future performance on certain contracts. Letters of credit and
surety bonds generally are available for draw down in the event we do not
perform. In some cases, we may guarantee the contractual performance of third
parties such as joint venture partners. At December 31, 2019, we had the
following outstanding letters of credit, surety bonds and third-party guarantees
(in millions):
                                                        Commitment Expiration By Period
                                   Total            Less Than         Years           Years         After
                                  Commitment         1 Year          2 and 3         4 and 5        5 Years

Standby letters of credit (a)   $       2,233     $     1,030     $       779     $       298     $        126
Surety bonds                              359             350               9               -                -
Third-party Guarantees                    996             199             317             151              329
Total commitments               $       3,588     $     1,579     $     1,105     $       449     $        455

(a) Approximately $725 million of standby letters of credit in the "Less Than 1

Year" category, $456 million in the "Years 2 and 3" category and $225

million in the "Years 4 and 5" category are expected to renew for additional

periods until completion of the contractual obligation.

At December 31, 2019, third-party guarantees totaled $996 million, of which
approximately 76% related to guarantees of contractual performance of joint
ventures to which we currently are or previously were a party. These amounts
represent our estimate of the maximum amounts we would expect to incur upon the
contractual non-performance of the joint venture, joint venture partners or
divested businesses. Generally, we also have cross-indemnities in place that may
enable us to recover amounts that may be paid on behalf of a joint venture
partner.
In determining our exposures, we evaluate the reputation, performance on
contractual obligations, technical capabilities and credit quality of our
current and former joint venture partners and the transferee under novation
agreements all of which include a guarantee as required by the FAR. There were
no material amounts recorded in our financial statements related to third-party
guarantees or novation agreements.
Critical Accounting Policies
Contract Accounting / Sales Recognition
The majority of our net sales are generated from long-term contracts with the
U.S. Government and international customers (including FMS contracted through
the U.S. Government) for the research, design, development, manufacture,
integration and sustainment of advanced technology systems, products and
services. We account for a contract when it has approval and commitment from
both parties, the rights of the parties are identified, payment terms are
identified, the contract has commercial substance and collectability of
consideration is probable. For certain contracts that meet the foregoing
requirements, primarily international direct commercial sale contracts, we are
required to obtain certain regulatory approvals. In these cases, we recognize
revenue based on the likelihood of obtaining regulatory approvals based upon all
known facts and circumstances. We provide our products and services under
fixed-price and cost-reimbursable contracts.
Under fixed-price contracts, we agree to perform the specified work for a
pre-determined price. To the extent our actual costs vary from the estimates
upon which the price was negotiated, we will generate more or less profit or
could incur a loss. Some fixed-price contracts have a performance-based
component under which we may earn incentive payments or incur financial
penalties based on our performance.
Cost-reimbursable contracts provide for the payment of allowable costs incurred
during performance of the contract plus a fee up to a ceiling based on the
amount that has been funded. Typically, we enter into three types of
cost-reimbursable contracts: cost-plus-award-fee, cost-plus-incentive-fee, and
cost-plus-fixed-fee. Cost-plus-award-fee contracts provide for an award fee that
varies within specified limits based on the customer's assessment of our
performance against a predetermined set of criteria, such as targets based on
cost, quality, technical and schedule criteria. Cost-plus-incentive-fee
contracts provide for reimbursement of costs plus a fee, which is adjusted by a
formula based on the relationship of total allowable costs to total target costs
(i.e., incentive based on cost) or reimbursement of costs plus an incentive to
exceed stated performance targets (i.e., incentive based on performance). The
fixed-fee in a cost-plus-fixed-fee contract is negotiated at the inception of
the contract and that fixed-fee does not vary with actual costs.

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We account for a contract after it has been approved by all parties to the
arrangement, the rights of the parties are identified, payment terms are
identified, the contract has commercial substance and collectability of
consideration is probable.
We assess each contract at its inception to determine whether it should be
combined with other contracts. When making this determination, we consider
factors such as whether two or more contracts were negotiated and executed at or
near the same time or were negotiated with an overall profit objective. If
combined, we treat the combined contracts as a single contract for revenue
recognition purposes.
We evaluate the products or services promised in each contract at inception to
determine whether the contract should be accounted for as having one or more
performance obligations. The products and services in our contracts are
typically not distinct from one another due to their complex relationships and
the significant contract management functions required to perform under the
contract. Accordingly, our contracts are typically accounted for as one
performance obligation. In limited cases, our contracts have more than one
distinct performance obligation, which occurs when we perform activities that
are not highly complex or interrelated or involve different product lifecycles.
Significant judgment is required in determining performance obligations, and
these decisions could change the amount of revenue and profit recorded in a
given period. We classify net sales as products or services on our consolidated
statements of earnings based on the predominant attributes of the performance
obligations.
We determine the transaction price for each contract based on the consideration
we expect to receive for the products or services being provided under the
contract. For contracts where a portion of the price may vary, we estimate
variable consideration at the most likely amount, which is included in the
transaction price to the extent it is probable that a significant reversal of
cumulative revenue recognized will not occur. We analyze the risk of a
significant revenue reversal and if necessary constrain the amount of variable
consideration recognized in order to mitigate this risk.
At the inception of a contract we estimate the transaction price based on our
current rights and do not contemplate future modifications (including
unexercised options) or follow-on contracts until they become legally
enforceable. Contracts are often subsequently modified to include changes in
specifications, requirements or price, which may create new or change existing
enforceable rights and obligations. Depending on the nature of the modification,
we consider whether to account for the modification as an adjustment to the
existing contract or as a separate contract. Generally, modifications to our
contracts are not distinct from the existing contract due to the significant
integration and interrelated tasks provided in the context of the contract.
Therefore, such modifications are accounted for as if they were part of the
existing contract and recognized as a cumulative adjustment to revenue.
For contracts with multiple performance obligations, we allocate the transaction
price to each performance obligation based on the estimated standalone selling
price of the product or service underlying each performance obligation. The
standalone selling price represents the amount we would sell the product or
service to a customer on a standalone basis (i.e., not bundled with any other
products or services). Our contracts with the U.S. Government, including FMS
contracts, are subject to FAR and the price is typically based on estimated or
actual costs plus a reasonable profit margin. As a result of these regulations,
the standalone selling price of products or services in our contracts with the
U.S. Government and FMS contracts are typically equal to the selling price
stated in the contract.
For non-U.S. Government contracts with multiple performance obligations, we
evaluate whether the stated selling prices for the products or services
represent their standalone selling prices. We primarily sell customized
solutions unique to a customer's specifications. When it is necessary to
allocate the transaction price to multiple performance obligations, we typically
use the expected cost plus a reasonable profit margin to estimate the standalone
selling price of each product or service. We occasionally sell standard products
or services with observable standalone sales transactions. In these situations,
the observable standalone sales transactions are used to determine the
standalone selling price.
We recognize revenue as performance obligations are satisfied and the customer
obtains control of the products and services. In determining when performance
obligations are satisfied, we consider factors such as contract terms, payment
terms and whether there is an alternative future use of the product or service.
Substantially all of our revenue is recognized over time as we perform under the
contract because control of the work in process transfers continuously to the
customer. For most contracts with the U.S. Government and FMS contracts, this
continuous transfer of control of the work in process to the customer is
supported by clauses in the contract that give the customer ownership of work in
process and allow the customer to unilaterally terminate the contract for
convenience and pay us for costs incurred plus a reasonable profit. For most
non-U.S. Government contracts, primarily international direct commercial
contracts, continuous transfer of control to our customer is supported because
we deliver products that do not have an alternative use to us and if our
customer were to terminate the contract for reasons other than our
non-performance we would have the right to recover damages which would include,
among other potential damages, the right to payment for our work performed to
date plus a reasonable profit.

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For performance obligations to deliver products with continuous transfer of
control to the customer, revenue is recognized based on the extent of progress
towards completion of the performance obligation, generally using the
percentage-of-completion cost-to-cost measure of progress for our contracts
because it best depicts the transfer of control to the customer as we incur
costs on our contracts. Under the percentage-of-completion cost-to-cost measure
of progress, the extent of progress towards completion is measured based on the
ratio of costs incurred to date to the total estimated costs to complete the
performance obligation(s). For performance obligations to provide services to
the customer, revenue is recognized over time based on costs incurred or the
right to invoice method (in situations where the value transferred matches our
billing rights) as our customer receives and consumes the benefits.
For performance obligations in which control does not continuously transfer to
the customer, we recognize revenue at the point in time in which each
performance obligation is fully satisfied. This coincides with the point in time
the customer obtains control of the product or service, which typically occurs
upon customer acceptance or receipt of the product or service, given that we
maintain control of the product or service until that point.
Significant estimates and assumptions are made in estimating contract sales and
costs, including the profit booking rate. At the outset of a long-term contract,
we identify and monitor risks to the achievement of the technical, schedule and
cost aspects of the contract, as well as variable consideration, and assess the
effects of those risks on our estimates of sales and total costs to complete the
contract. The estimates consider the technical requirements (e.g., a
newly-developed product versus a mature product), the schedule and associated
tasks (e.g., the number and type of milestone events) and costs (e.g., material,
labor, subcontractor, overhead, general and administrative and the estimated
costs to fulfill our industrial cooperation agreements, sometimes referred to as
offset or localization agreements, required under certain contracts with
international customers). The initial profit booking rate of each contract
considers risks surrounding the ability to achieve the technical requirements,
schedule and costs in the initial estimated total costs to complete the
contract. Profit booking rates may increase during the performance of the
contract if we successfully retire risks surrounding the technical, schedule and
cost aspects of the contract, which decreases the estimated total costs to
complete the contract or may increase the variable consideration we expect to
receive on the contract. Conversely, our profit booking rates may decrease if
the estimated total costs to complete the contract increase or our estimates of
variable consideration we expect to receive decrease. All of the estimates are
subject to change during the performance of the contract and may affect the
profit booking rate. When estimates of total costs to be incurred on a contract
exceed total estimates of the transaction price, a provision for the entire loss
is determined at the contract level and is recorded in the period in which the
loss is determined.
Comparability of our segment sales, operating profit and operating margin may be
impacted favorably or unfavorably by changes in profit booking rates on our
contracts for which we recognize revenue over time using the
percentage-of-completion cost-to-cost method to measure progress towards
completion. Increases in the profit booking rates, typically referred to as risk
retirements, usually relate to revisions in the estimated total costs to fulfill
the performance obligations that reflect improved conditions on a particular
contract. Conversely, conditions on a particular contract may deteriorate,
resulting in an increase in the estimated total costs to fulfill the performance
obligations and a reduction in the profit booking rate. Increases or decreases
in profit booking rates are recognized in the current period and reflect the
inception-to-date effect of such changes. Segment operating profit and margin
may also be impacted favorably or unfavorably by other items, which may or may
not impact sales. Favorable items may include the positive resolution of
contractual matters, cost recoveries on severance and restructuring charges,
insurance recoveries and gains on sales of assets. Unfavorable items may include
the adverse resolution of contractual matters; restructuring charges, except for
significant severance actions, which are excluded from segment operating
results; reserves for disputes; certain asset impairments; and losses on sales
of certain assets.
Other Contract Accounting Considerations
The majority of our sales are driven by pricing based on costs incurred to
produce products or perform services under contracts with the U.S. Government.
Cost-based pricing is determined under the FAR. The FAR provides guidance on the
types of costs that are allowable in establishing prices for goods and services
under U.S. Government contracts. For example, costs such as those related to
charitable contributions, interest expense and certain advertising and public
relations activities are unallowable and, therefore, not recoverable through
sales. In addition, we may enter into advance agreements with the U.S.
Government that address the subjects of allowability and allocability of costs
to contracts for specific matters. For example, most of the environmental costs
we incur for environmental remediation related to sites operated in prior years
are allocated to our current operations as general and administrative costs
under FAR provisions and supporting advance agreements reached with the U.S.
Government.
We closely monitor compliance with and the consistent application of our
critical accounting policies related to contract accounting. Costs incurred and
allocated to contracts are reviewed for compliance with U.S. Government
regulations by our personnel and are subject to audit by the Defense Contract
Audit Agency.

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Postretirement Benefit Plans
Overview
Many of our employees and retirees participate in qualified and nonqualified
defined benefit pension plans, retiree medical and life insurance plans and
other postemployment plans (collectively, postretirement benefit plans - see
"Note 11 - Postretirement Benefit Plans" included in our Notes to Consolidated
Financial Statements). The majority of our accrued benefit obligations relate to
our qualified defined benefit pension plans and retiree medical and life
insurance plans. We recognize on a plan-by-plan basis the net funded status of
these postretirement benefit plans under GAAP as either an asset or a liability
on our consolidated balance sheets. The GAAP funded status represents the
difference between the fair value of each plan's assets and the benefit
obligation of the plan. The GAAP benefit obligation represents the present value
of the estimated future benefits we currently expect to pay to plan participants
based on past service.
We completed the final step of the previously announced planned freeze of our
qualified and nonqualified defined benefit pension plans for salaried employees
effective January 1, 2020. The freeze took effect in two stages. Effective
January 1, 2016, the pay-based component of the formula used to determine
retirement benefits was frozen. Effective January 1, 2020, the service-based
component of the formula was frozen. As a result of these changes, the qualified
defined benefit pension plans for salaried employees are fully frozen effective
January 1, 2020. With the freeze complete, the majority of our salaried
employees participate in an enhanced defined contribution retirement savings
plan.
We may from time to time take actions to mitigate the effect of our defined
benefit pension plans on our financial results by reducing the volatility of our
pension obligations, including entering into additional transactions involving
the purchase of a group annuity contract for a portion of our outstanding
defined benefit pension obligations using assets from the pension trust. During
December 2019, Lockheed Martin, through its master retirement trust, purchased
an irrevocable group annuity contract from an insurance company (referred to as
a buy-out contract) for $1.9 billion to transfer $1.9 billion of our outstanding
defined benefit pension obligations related to certain U.S. retirees and
beneficiaries. The group annuity contract was purchased using assets from the
pension trust. As a result of this transaction, we were relieved of all
responsibility for these pension obligations and the insurance company is now
required to pay and administer the retirement benefits owed to approximately
20,000 U.S. retirees and beneficiaries, with no change to the amount, timing or
form of monthly retirement benefit payments. Although the transaction was
treated as a settlement for accounting purposes, we did not recognize a loss on
the settlement in earnings associated with the transaction because total
settlements during 2019 for the affected pension plans were less than the plans'
service and interest cost in 2019. Accordingly, the transaction had no impact on
our 2019 FAS pension expense or CAS pension cost, and the difference of
approximately $45 million between the amount paid to the insurance company and
the amount of the pension obligations settled was recognized in other
comprehensive income and will be amortized to FAS pension expense in future
periods. We expect to continue to look for opportunities to manage our pension
liabilities through additional buy out contracts in future years and the amounts
involved could be material to a particular reporting period. Future transactions
could result in a non-cash settlement charge to earnings, which could be
material to a reporting period.

Also, during December 2018, Lockheed Martin, through its master retirement
trust, purchased two contracts from insurance companies for $2.6 billion related
to our outstanding defined benefit pension obligations. One of the contracts we
purchased was an irrevocable group annuity contract from an insurance company
(referred to as a buy-out contract), which relieved us of all responsibility for
the pension obligations related to approximately 32,000 U.S. retirees and
beneficiaries. The second contract was structured as a buy-in contract (that
will reimburse the pension plan for all future benefit payments related to
defined benefit obligations for approximately 9,000 U.S retirees and
beneficiaries). The buy-in contract is accounted for at fair value as an
investment of the trust.

Notwithstanding these actions, the impact of these plans and benefits on our
earnings may be volatile in that the amount of expense we record and the funded
status for our postretirement benefit plans may materially change from year to
year because those calculations are sensitive to funding levels as well as
changes in several key economic assumptions, including interest rates, actual
rates of return on plan assets and other actuarial assumptions including
participant longevity and employee turnover, as well as the timing of cash
funding.

Actuarial Assumptions
The plan assets and benefit obligations are measured at the end of each year or
more frequently, upon the occurrence of certain events such as a significant
plan amendment, settlement or curtailment. The amounts we record are measured
using actuarial valuations, which are dependent upon key assumptions such as
discount rates, the expected long-term rate of return on plan assets,
participant longevity, employee turnover and the health care cost trend rates
for our retiree medical plans. The assumptions we make affect both the
calculation of the benefit obligations as of the measurement date and the
calculation of net periodic benefit

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cost in subsequent periods. When reassessing these assumptions we consider past
and current market conditions and make judgments about future market trends. We
also consider factors such as the timing and amounts of expected contributions
to the plans and benefit payments to plan participants.
We continue to use a single weighted average discount rate approach when
calculating our consolidated benefit obligations related to our defined benefit
pension plans resulting in 3.25% at December 31, 2019, compared to 4.25% at
December 31, 2018. We utilized a single weighted average discount rate of 3.25%
when calculating our benefit obligations related to our retiree medical and life
insurance plans at December 31, 2019, compared to 4.25% at December 31, 2018. We
evaluate several data points in order to arrive at an appropriate single
weighted average 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 calculate the approximate average
yields on corporate bonds rated AA or better selected to match our projected
postretirement benefit plan cash flows. The decrease in the discount rate from
December 31, 2018 to December 31, 2019 resulted in an approximate $5.8 billion
increase in the projected benefit obligations of our qualified defined benefit
pension plans.
We utilized an expected long-term rate of return on plan assets of 7.00% at
December 31, 2019 compared to 7.00% for December 31, 2018. 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. Any variance in a given year should not, by itself, suggest that
the assumption should be changed. Patterns of variances are reviewed over time,
and then combined with expectations for the future. As a result, changes in this
assumption are less frequent than changes in the discount rate. The actual
investment return for our qualified defined benefit plans during 2019 of $6.7
billion based on an actual rate of approximately 21% improved plan assets more
than the $2.3 billion expected return based on our 7.00% long-term rate of
return assumption.
In October 2019, the Society of Actuaries published revised longevity
assumptions that refined its prior studies. We used the revised assumptions in
our December 31, 2019 re-measurement of benefit obligation. We reflected a
longevity basis specific to the demographics of the underlying population (e.g.,
the nature of the work), versus the prior basis which was blended for all types
of work, resulting in an approximate $860 million increase in the projected
benefit obligations of our qualified defined benefit pension plans.
Our stockholders' equity has been reduced cumulatively by $15.5 billion from the
annual year-end measurements of the funded status of postretirement benefit
plans. The cumulative non-cash, after-tax reduction primarily represents net
actuarial losses resulting from declines in discount rates, investment losses
and updated longevity. A market-related value of our plan assets, determined
using actual asset gains or losses over the prior three year period, is used to
calculate the amount of deferred asset gains or losses to be amortized. These
cumulative actuarial losses will be amortized to expense using the corridor
method, where gains and losses are recognized to the extent they exceed 10% of
the greater of plan assets or benefit obligations, over an average period of
approximately twenty years as of December 31, 2019. This amortization period
extended (approximately doubled from the prior nine years) in 2020 due to the
freeze of our salaried pension plans to use the average remaining life
expectancy of the participants instead of average future service. During 2019,
$908 million of these amounts were recognized as a component of postretirement
benefit plans expense and about $441 million is expected to be recognized as
expense in 2020.
The discount rate and long-term rate of return on plan assets assumptions we
select at the end of each year are based on our best estimates and judgment. A
change of plus or minus 25 basis points in the 3.25% discount rate assumption at
December 31, 2019, with all other assumptions held constant, would have
decreased or increased the amount of the qualified pension benefit obligation we
recorded at the end of 2019 by approximately $1.5 billion, which would result in
an after-tax increase or decrease in stockholders' equity at the end of the year
of approximately $1.2 billion. If the 3.25% discount rate at December 31, 2019
that was used to compute the expected 2020 FAS pension expense for our qualified
defined benefit pension plans had been 25 basis points higher or lower, with all
other assumptions held constant, the amount of FAS pension expense projected for
2020 would be lower or higher by approximately $15 million. The impact of
changes in the discount rate on FAS pension expense is significantly less than
in prior years (i.e., $15 million for 2020 compared to $120 million for 2019)
due to the freeze of our salaried pension plans effective January 1, 2020, and
resulting service cost reduction and extended loss amortization period discussed
above. If the 7.00% expected long-term rate of return on plan assets assumption
at December 31, 2019 that was used to compute the expected 2020 FAS pension
expense for our qualified defined benefit pension plans had been 25 basis points
higher or lower, with all other assumptions held constant, the amount of FAS
pension expense projected for 2020 would be lower or higher by approximately $80
million. Each year, differences between the actual plan asset return and the
expected long-term rate of return on plan assets

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impacts the measurement of the following year's FAS expense. Every 100 basis
points difference in return during 2019 between our actual rate of return of
approximately 21% and our expected long-term rate of return of 7.00% impacted
2020 expected FAS pension expense by approximately $15 million.
Funding Considerations
We made contributions of $1.0 billion in 2019 and $5.0 billion in 2018 to our
qualified defined benefit pension plans. Funding of our qualified 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). Our goal has been to fund
the pension plans to a level of at least 80%, as determined under the PPA. The
ERISA funded status of our qualified defined benefit pension plans was
approximately 82% and 81% as of December 31, 2019 and 2018; which is calculated
on a different basis than under GAAP.
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. Pension cost recoveries under
CAS occur in different periods from when pension contributions are made under
the PPA. The CAS rules fully transitioned in 2017 to better align the recovery
of pension costs with the minimum funding requirements of the PPA (referred to
as CAS Harmonization).
We recovered $2.6 billion in 2019 and $2.4 billion in 2018 as CAS pension costs.
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. Our prepayment credits were approximately $8.5 billion at both
December 31, 2019 and 2018. The prepayment credit balance will increase or
decrease based on our actual investment return on plan assets.
Trends
We made contributions to our qualified defined benefit pension plans of $1.0
billion in 2019 and $5.0 billion in 2018, including required and discretionary
contributions. As a result of these contributions, we do not expect to make
contributions to our qualified defined benefit pension plans in 2020. We
anticipate recovering approximately $2.0 billion of CAS pension cost in 2020
allowing us to recoup a portion of our CAS prepayment credits.
We project FAS pension income of $115 million in 2020, compared to FAS pension
expense of $1.1 billion in 2019, as a result of completing the planned freeze of
our salaried pension plans effective January 1, 2020 that was previously
announced on July 1, 2014. Our FAS pension expense is comprised of service cost,
interest cost, expected return on plan assets, amortization of prior service
cost or credit, and amortization of actuarial losses. The service cost and
amortization of actuarial losses components of FAS pension expense are
significantly lower due to the freeze. As a result, the expected return on plan
assets and amortization of prior service credit exceed all other FAS pension
expense components in 2020.
Environmental Matters
We are a party to various agreements, proceedings and potential proceedings for
environmental remediation issues, including matters at various sites where we
have been designated a potentially responsible party (PRP). At December 31, 2019
and 2018, the total amount of liabilities recorded on our consolidated balance
sheet for environmental matters was $810 million and $864 million. We have
recorded assets totaling $703 million and $750 million at December 31, 2019 and
2018 for the portion of environmental costs that are probable of future recovery
in pricing of our products and services for agencies of the U.S. Government, as
discussed below. The amount that is expected to be allocated to our non-U.S.
Government contracts or that is determined to not be recoverable under U.S.
Government contracts has been expensed through cost of sales. We project costs
and recovery of costs over approximately 20 years.
We enter into agreements (e.g., administrative consent orders, consent decrees)
that document the extent and timing of some of our environmental remediation
obligations. We also are involved in environmental remediation activities at
sites where formal agreements either do not exist or do not quantify the extent
and timing of our obligations. Environmental remediation activities usually span
many years, which makes estimating the costs more judgmental due to, for
example, changing remediation technologies. To determine the costs related to
clean up sites, we have to assess the extent of contamination, effects on
natural resources, the appropriate technology to be used to accomplish the
remediation and evolving environmental standards.
We perform quarterly reviews of environmental remediation sites and record
liabilities and receivables in the period it becomes probable that a liability
has been incurred and the amounts can be reasonably estimated (see the
discussion under "Environmental Matters" in "Note 1 - Significant Accounting
Policies" and "Note 14 - Legal Proceedings, Commitments and Contingencies"

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included in our Notes to Consolidated Financial Statements). We consider the
above factors in our quarterly estimates of the timing and amount of any future
costs that may be required for environmental remediation activities, which
results in the calculation of a range of estimates for a particular
environmental remediation site. We do not discount the recorded liabilities, as
the amount and timing of future cash payments are not fixed or cannot be
reliably determined. Given the required level of judgment and estimation, it is
likely that materially different amounts could be recorded if different
assumptions were used or if circumstances were to change (e.g., a change in
environmental standards or a change in our estimate of the extent of
contamination).
Under agreements reached with the U.S. Government, most of the amounts we spend
for environmental remediation are allocated to our operations as general and
administrative costs. Under existing U.S. Government regulations, these and
other environmental expenditures relating to our U.S. Government business, after
deducting any recoveries received from insurance or other PRPs, are allowable in
establishing prices of our products and services. As a result, most of the
expenditures we incur are included in our net sales and cost of sales according
to U.S. Government agreement or regulation, regardless of the contract form
(e.g. cost-reimbursable, fixed-price). We continually evaluate the
recoverability of our assets for the portion of environmental costs that are
probable of future recovery by assessing, among other factors, U.S. Government
regulations, our U.S. Government business base and contract mix, our history of
receiving reimbursement of such costs, and efforts by some U.S. Government
representatives to limit such reimbursement.
In addition to the proceedings and potential proceedings discussed above,
California previously established a maximum level of the contaminant hexavalent
chromium in drinking water of 10 parts per billion (ppb). This standard was
successfully challenged by the California Manufacturers and Technology
Association (CMTA) for failure to conduct the required economic feasibility
analysis. In response to the court's ruling, the State Water Resources Control
Board (State Board), a branch of the California Environmental Protection Agency,
withdrew the hexavalent chromium standard from the published regulations,
leaving only the 50 ppb standard for total chromium. The State Board has
indicated it will work to re-establish a hexavalent chromium standard. Further,
the U.S. Environmental Protection Agency (U.S. EPA) is considering whether to
regulate hexavalent chromium.
California is also reevaluating its existing drinking water standard of 6 ppb
for perchlorate, and the U.S. EPA is taking steps to regulate perchlorate in
drinking water. If substantially lower standards are adopted, in either
California or at the federal level for perchlorate or for hexavalent chromium,
we expect a material increase in our estimates for environmental liabilities and
the related assets for the portion of the increased costs that are probable of
future recovery in the pricing of our products and services for the U.S.
Government. The amount that would be allocable to our non-U.S. Government
contracts or that is determined not to be recoverable under U.S. Government
contracts would be expensed, which may have a material effect on our earnings in
any particular interim reporting period.
As disclosed above, we may record changes in the amount of environmental
remediation liabilities as a result of our quarterly reviews of the status of
our environmental remediation sites, which would result in a change to the
corresponding amount that is probable of future recovery and a charge to
earnings. For example, if we were to determine that the liabilities should be
increased by $100 million, the corresponding amount that is probable of future
recovery would be increased by approximately $87 million, with the remainder
recorded as a charge to earnings. This allocation is determined annually, based
upon our existing and projected business activities with the U.S. Government.
We cannot reasonably determine the extent of our financial exposure at all
environmental remediation sites with which we are involved. There are a number
of former operating facilities we are monitoring or investigating for potential
future environmental remediation. In some cases, although a loss may be
probable, it is not possible at this time to reasonably estimate the amount of
any obligation for remediation activities because of uncertainties (e.g.,
assessing the extent of the contamination). During any particular quarter, such
uncertainties may be resolved, allowing us to estimate and recognize the initial
liability to remediate a particular former operating site. The amount of the
liability could be material. Upon recognition of the liability, a portion will
be recognized as a receivable with the remainder charged to earnings, which may
have a material effect in any particular interim reporting period.
If we are ultimately found to have liability at those sites where we have been
designated a PRP, we expect that the actual costs of environmental remediation
will be shared with other liable PRPs. Generally, PRPs that are ultimately
determined to be responsible parties are strictly liable for site remediation
and usually agree among themselves to share, on an allocated basis, the costs
and expenses for environmental investigation and remediation. Under existing
environmental laws, responsible parties are jointly and severally liable and,
therefore, we are potentially liable for the full cost of funding such
remediation. In the unlikely event that we were required to fund the entire cost
of such remediation, the statutory framework provides that we may pursue rights
of cost recovery or contribution from the other PRPs. The amounts we record do
not reflect the fact that we may recover some of the environmental costs we have
incurred through insurance or from other PRPs, which we are required to pursue
by agreement and U.S. Government regulation.

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Goodwill and Intangible Assets
The assets and liabilities of acquired businesses are recorded under the
acquisition method of accounting at their estimated fair values at the date of
acquisition. Goodwill represents costs in excess of fair values assigned to the
underlying identifiable net assets of acquired businesses. Intangible assets
from acquired businesses are recognized at fair value on the acquisition date
and consist of customer programs, trademarks, customer relationships, technology
and other intangible assets. Customer programs include values assigned to major
programs of acquired businesses and represent the aggregate value associated
with the customer relationships, contracts, technology and trademarks underlying
the associated program and are amortized on a straight-line basis over a period
of expected cash flows used to measure fair value, which ranges from nine to 20
years.
Our goodwill balance was $10.6 billion at December 31, 2019 and $10.8 billion at
December 31, 2018. We perform an impairment test of our goodwill at least
annually in the fourth quarter or more frequently whenever events or changes in
circumstances indicate the carrying value of goodwill may be impaired. Such
events or changes in circumstances may include a significant deterioration in
overall economic conditions, changes in the business climate of our industry, a
decline in our market capitalization, operating performance indicators,
competition, reorganizations of our business, U.S. Government budget
restrictions or the disposal of all or a portion of a reporting unit. Our
goodwill has been allocated to and is tested for impairment at a level referred
to as the reporting unit, which is our business segment level or a level below
the business segment. The level at which we test goodwill for impairment
requires us to determine whether the operations below the business segment
constitute a self-sustaining business for which discrete financial information
is available and segment management regularly reviews the operating results.
We may use both qualitative and quantitative approaches when testing goodwill
for impairment. For selected reporting units where we use the qualitative
approach, we perform a qualitative evaluation of events and circumstances
impacting the reporting unit to determine the likelihood of goodwill impairment.
Based on that qualitative evaluation, if we determine it is more likely than not
that the fair value of a reporting unit exceeds its carrying amount, no further
evaluation is necessary. Otherwise we perform a quantitative impairment test. We
perform quantitative tests for most reporting units at least once every three
years. However, for certain reporting units we may perform a quantitative
impairment test every year.
To perform the quantitative impairment test, we compare the fair value of a
reporting unit to its carrying value, including goodwill. If the fair value of a
reporting unit exceeds its carrying value, goodwill of the reporting unit is not
impaired. If the carrying value of the reporting unit, including goodwill,
exceeds its fair value, a goodwill impairment loss is recognized in an amount
equal to that excess. We generally estimate the fair value of each reporting
unit using a combination of a discounted cash flow (DCF) analysis and
market-based valuation methodologies such as comparable public company trading
values and values observed in recent business acquisitions. Determining fair
value requires the exercise of significant judgments, including the amount and
timing of expected future cash flows, long-term growth rates, discount rates and
relevant comparable public company earnings multiples and relevant transaction
multiples. The cash flows employed in the DCF analysis are based on our best
estimate of future sales, earnings and cash flows after considering factors such
as general market conditions, U.S. Government budgets, existing firm orders,
expected future orders, contracts with suppliers, labor agreements, changes in
working capital, long term business plans and recent operating performance. The
discount rates utilized in the DCF analysis are based on the respective
reporting unit's weighted average cost of capital, which takes into account the
relative weights of each component of capital structure (equity and debt) and
represents the expected cost of new capital, adjusted as appropriate to consider
the risk inherent in future cash flows of the respective reporting unit. The
carrying value of each reporting unit includes the assets and liabilities
employed in its operations, goodwill and allocations of amounts held at the
business segment and corporate levels.
In the fourth quarter of 2019, we performed our annual goodwill impairment test
for each of our reporting units. The results of that test indicated that for
each of our reporting units no impairment existed. As of the date of our annual
impairment test, the fair value of our Sikorsky reporting unit exceeded its
carrying value, which included goodwill of $2.7 billion, by a margin of
approximately 40%. While the margin between the fair value and carrying value of
our Sikorsky reporting unit improved since the prior year impairment test, the
fair value of our Sikorsky reporting unit can be significantly impacted by
changes in expected future orders, discount rates and long term growth rates,
along with other significant judgments. Based on our assessment of these
circumstances, we have determined that goodwill at our Sikorsky reporting unit
is at risk for impairment should there be a deterioration of projected cash
flows of the reporting unit.
Impairment assessments inherently involve management judgments regarding a
number of assumptions such as those 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.
Acquired intangible assets deemed to have indefinite lives are not amortized,
but are subject to annual impairment testing. This testing compares carrying
value to fair value and, when appropriate, the carrying value of these assets is
reduced to fair value.

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Finite-lived intangibles are amortized to expense over the applicable useful
lives, ranging from three to 20 years, based on the nature of the asset and the
underlying pattern of economic benefit as reflected by future net cash inflows.
We perform an impairment test of finite-lived intangibles whenever events or
changes in circumstances indicate their carrying value may be impaired. If
events or changes in circumstances indicate the carrying value of a finite-lived
intangible may be impaired, the sum of the undiscounted future cash flows
expected to result from the use of the asset group would be compared to the
asset group's carrying value. If the asset group's carrying amount exceed the
sum of the undiscounted future cash flows, we would determine the fair value of
the asset group and record an impairment loss in net earnings.
The carrying value of our Sikorsky business includes an indefinite-lived
trademark intangible asset of $887 million as of December 31, 2019. In the
fourth quarter of 2019, we performed the annual impairment test for the Sikorsky
indefinite-lived trademark intangible asset and the results indicated that no
impairment existed. As of the date of our annual impairment test, the fair value
of the Sikorsky trademark exceeded its carrying value by a margin of
approximately 10%. Additionally, our Sikorsky business has finite-lived customer
program intangible assets with carrying values of $2.2 billion as of
December 31, 2019. Any business deterioration, contract cancellations or
terminations, or negative changes in market factors could cause our sales to
decline below current projections. Based on our assessment of these
circumstances, we have determined that our Sikorsky intangible assets are at
risk for impairment should there be any business deterioration, contract
cancellations or terminations, or negative changes in market factors.
Recent Accounting Pronouncements
See "Note 1 - Significant Accounting Policies" included in our Notes to
Consolidated Financial Statements (under the caption "Recent Accounting
Pronouncements").

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