Item 2. Management’s Discussion and Analysis
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 to consolidated financial statements and with our Annual Report on Form 10-K for the year ended December 31, 2022 (2022 Form 10-K).
BUSINESS OVERVIEW
We are a global security and aerospace company principally engaged in the research, design, development, manufacture, integration and sustainment of advanced technology systems, products and services. We also provide a broad range of management, engineering, technical, scientific, logistics, system integration and cybersecurity services. Our main areas of focus are in defense, space, intelligence, homeland security and information technology, including cybersecurity. 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. During the nine months ended September 24, 2023, 74% of our $48.7 billion in net sales were from the U.S. Government, either as a prime contractor or as a subcontractor (including 64% from the Department of Defense (DoD)), 25% 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.
U.S. Budget Environment
With nearly three quarters of our sales from the U.S. government, U.S. government spending levels, particularly defense spending, and timely funding thereof can affect our financial performance over the short and long term.
The President’s Fiscal Year (FY) 2024 budget request was submitted to Congress on March 9, 2023, initiating the FY 2024 defense authorization and appropriations legislative process. The request includes $886 billion for National Defense, of which $842 billion is for the DoD base budget.
On June 3, 2023, the President signed H.R. 3746 “The Fiscal Responsibility Act” (FRA) into law. The legislation suspends the debt ceiling until January 1, 2025, and, among other provisions, caps national defense spending at $886 billion for FY 2024 (President’s Budget Request level) and $895 billion for FY 2025. Supplemental funding legislation is not subject to the budget caps.
Additionally, the FRA will result in a decrease in government spending for FY 2024 by one percent from FY 2023 enacted levels if Congress does not pass all twelve defense and non-defense discretionary appropriations bills by the end of 2023. If all twelve bills are not enacted, the sequestration process would be initiated on January 1, 2024, with effective implementation no later than April 30, 2024.
The House and Senate continue the legislative process on the FY 2024 budget. Final passage of the FY 2024 National Defense Authorization Act (NDAA) is anticipated before the end of the calendar year. Congress will also continue its effort to move appropriations bills and conference agreements, but these actions are dependent on the House leadership vote and Senate calendar. The FRA spending cap limits the ability of the defense committees to support significant increases in program funding without supplemental or emergency funding designations. Overall, congressional sentiment remains strong for supporting the National Defense Strategy and defense spending.
On September 30, 2023, the President signed a continuing resolution to continue funding the U.S government at FY 2023 levels through the earlier of November 17, 2023, or until FY 2024 appropriations bills are enacted. Under the continuing resolution, funding at amounts consistent with appropriated levels for FY 2023 are available, subject to certain restrictions, but new contract and program starts are not authorized. We expect our key programs will continue to be supported and funded under the continuing resolution. However, during periods covered by continuing resolutions, we may experience delays in new awards of our products and services, and those delays may adversely affect our results of operations.
If Congress is not able to enact FY 2024 appropriations bills or extend the continuing resolution, the U.S. government will enter a whole or partial shutdown. The impact of any government shutdown is uncertain. However, if a government shutdown were to occur and were to continue for an extended period, we could be at risk of program cancellations, schedule delays, production halts and other disruptions and nonpayment, which could adversely affect our results of operations.
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We anticipate the federal budget will continue to be subject to debate and compromise shaped by, among other things, heightened political tensions, the global security environment, inflationary pressures, and macroeconomic conditions. The result may be shifting funding priorities, which could have material impacts on defense spending broadly and our programs.
See also the discussion of U.S. Government funding risks within “Item 1A, Risk Factors” included in our 2022 Form 10-K.
Geopolitical and Economic Environment
We operate in a complex and evolving global security environment and our business is affected by geopolitical issues. Russia’s invasion of Ukraine significantly elevated global geopolitical tensions and security concerns resulting in increased interest for certain of our products and services as countries seek to improve their security posture. In addition, security assistance provided by the U.S. Government and its allies to Ukraine has created U.S. Government and allied demand to replenish U.S. stockpiles, resulting in additional and potential future orders for our products, including for the ramp-up in production capacity for certain products. However, given the long-cycle nature of our business and current industry capacity, we do not expect a significant increase in 2023 sales from new contracts in response to the conflict. We continue to work with the U.S. Government and our supply chain to evaluate increases in capacity at certain of our operations to anticipate potential demand and enable us to deliver critical capabilities.
Our business and financial performance is also affected by general economic conditions. Supply chain disruptions persist, and we continue to experience supply chain challenges, including supplier shortages and performance issues, which have delayed certain customer deliveries and adversely impacted our performance and our financial results year to date. While we continue working to minimize the impact of supply chain challenges, many of these challenges are industry wide or caused by geopolitical events that are outside of our control. In addition, heightened levels of inflation and the potential worsening of macro-economic conditions present risks for Lockheed Martin, our suppliers and the stability of the broader defense industrial base. Certain costs, including rising labor rates and supplier costs, on several of our programs have increased as a result of inflation, and put pressure on achieving our expected margins on the programs. In addition, some suppliers are reducing the typical duration of pricing validity in their proposals to us, which can be operationally challenging and increase the risk of cost volatility. If we continue to experience high rates of inflation, and we are unable to successfully mitigate the impact, our future profits, margins and cash flows, particularly for existing fixed-price contracts, may be adversely affected. Inflation and higher interest rates can also constrain the overall purchasing power of our customers for our products and services potentially impacting future orders. We remain committed to our ongoing efforts to increase the efficiency of our operations and improve the cost competitiveness and affordability of our products and services, which may, in part, offset cost increases from inflation.
For additional risks to the company related to the geopolitical and economic environment, see Item 1A, Risk Factors of our 2022 Form 10-K.
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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 should be reviewed in this context. All per share amounts cited in these discussions are presented on a “per diluted share” basis, unless otherwise noted. Our consolidated results of operations were as follows (in millions, except per share data):
Quarters Ended Nine Months Ended
September 24,
2023 September 25,
2022 September 24,
2023 September 25,
2022
Net sales $ 16,878 $ 16,583 $ 48,697 $ 46,993
Cost of sales (14,830) (14,463) (42,513) (41,008)
Gross profit 2,048 2,120 6,184 5,985
Other (expense) income, net (6) 39 30 70
Operating profit 2,042 2,159 6,214 6,055
Interest expense (237) (145) (662) (421)
Non-service FAS pension income (expense) 111 111 332 (1,080)
Other non-operating income (expense), net 37 (26) 69 (64)
Earnings before income taxes 1,953 2,099 5,953 4,490
Income tax expense (269) (321) (899) (670)
Net earnings $ 1,684 $ 1,778 $ 5,054 $ 3,820
Diluted earnings per common share $ 6.73 $ 6.71 $ 19.97 $ 14.31
Certain amounts reported in other income, net, including our share of earnings or losses from equity method investees, are included in the operating profit of our business segments. Accordingly, such amounts are included in the discussion of our business segment results of operations.
Net Sales
We generate sales from the delivery of products and services to our customers. Our consolidated net sales were as follows (in millions):
Quarters Ended Nine Months Ended
September 24,
2023 September 25,
2022 September 24,
2023 September 25,
2022
Products $ 14,014 $ 14,011 $ 40,298 $ 39,266
% of total net sales 83.0 % 84.5 % 82.8 % 83.6 %
Services 2,864 2,572 8,399 7,727
% of total net sales 17.0 % 15.5 % 17.2 % 16.4 %
Total net sales $ 16,878 $ 16,583 $ 48,697 $ 46,993
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.
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Product Sales
Product sales during the quarter ended September 24, 2023 were comparable to the same period in 2022. Lower product sales of $535 million at Aeronautics were mostly offset by higher product sales of $280 million at RMS and $175 million at Space. Lower product sales at Aeronautics were due to lower volume on F-35 production contracts. Higher product sales at RMS were due to higher volume on various integrated warfare systems and sensors (IWSS) programs. Higher product sales at Space were due to higher volume on strategic and missile defense programs (Next Generation Interceptor (NGI) development and Fleet Ballistic Missile (FBM)).
Product sales increased $1.0 billion, or 3%, during the nine months ended September 24, 2023 compared to the same period in 2022. The increase was primarily attributable to higher product sales of $845 million at Space due to higher volume for strategic and missile defense programs (NGI development and FBM) and national security space programs (Global Positioning System (GPS) III,Transport Layer development and classified development programs).
Service Sales
Service sales increased $292 million, or 11%, during the quarter ended September 24, 2023 compared to the same period in 2022. The increase was primarily attributable to higher sales of approximately $165 million at Aeronautics due to higher volume on F-35 sustainment contracts.
Service sales increased $672 million, or 9%, during the nine months ended September 24, 2023 compared to the same period in 2022. The increase was primarily attributable to higher sales of approximately $465 million at Aeronautics due to higher volume on F-35 sustainment contracts and $115 million at Space due to higher volume on national security space programs (classified development and Space-Based Infrared System (SBIRS)).
Cost of Sales
Cost of sales, for both products and services, consist of materials, labor, subcontracting costs and 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):
Quarters Ended Six Months Ended (a)
September 24,
2023 September 25,
2022 September 24,
2023 September 25,
2022
Cost of sales – products $ (12,571) $ (12,493) $ (35,960) $ (34,939)
% of product sales 89.7 % 89.2 % 89.2 % 89.0 %
Cost of sales – services (2,510) (2,235) (7,436) (6,758)
% of service sales 87.6 % 86.9 % 88.5 % 87.5 %
Other unallocated, net 251 265 883 689
Total cost of sales $ (14,830) $ (14,463) $ (42,513) $ (41,008)
(a) Effective January 1, 2023, we reclassified intangible asset amortization expense out of the business segment operating profit and into the unallocated items line item to better align with how management views and manages the business. See “Note 1 - Basis of Presentation” included in our Notes to Consolidated Financial Statements for further information regarding the impact of this change on our current and prior period segment operating profit.
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. Except for potential impacts to our programs resulting from supply chain disruptions and inflation, we have not identified any additional 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 $78 million, or 1%, during the quarter ended September 24, 2023 compared to the same period in 2022. The increase was primarily attributable to higher product costs of $245 million at RMS, and $200 million at
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Space, offset by lower product costs of $445 million at Aeronautics. Higher product costs at RMS were due to higher volume on various IWSS programs. Higher product costs at Space were due to higher volume for strategic and missile defense programs (NGI development and FBM) and national security space programs (GPS III). Lower product costs at Aeronautics were due to lower volume on F-35 production contracts.
Product costs increased $1.0 billion, or 3%, during the nine months ended September 24, 2023 compared to the same period in 2022. The increase was primarily attributable to higher product costs of $775 million at Space due to higher volume for strategic and missile defense programs (NGI development and FBM) and national security space programs (GPS III,Transport Layer development and classified development programs).
Service Costs
Service costs increased $275 million, or 12%, during the quarter ended September 24, 2023 compared to the same period in 2022. The increase was primarily attributable to higher service costs of approximately $155 million at Aeronautics due to higher volume on F-35 sustainment contracts.
Service costs increased $678 million, or 10%, during the nine months ended September 24, 2023 compared to the same period in 2022. The increase was primarily attributable to higher service costs of approximately $440 million at Aeronautics due to higher volume on F-35 sustainment contracts and $100 million at Space due to higher volume on national security space programs (classified and SBIRS).
Other Unallocated, Net
Other unallocated, net primarily includes the FAS/CAS pension operating adjustment (which represents the difference between total CAS pension cost recorded in our business segments’ results of operations and the service cost component of Financial Accounting Standards (FAS) pension expense), stock-based compensation expense, changes in the fair value of assets and liabilities for deferred compensation plans, intangible asset amortization expense and other corporate costs. These items are not allocated to the business segments and, therefore, are not allocated to cost of sales for products or services. Other unallocated, net reduced cost of sales by $251 million and $883 million during the quarter and nine months ended September 24, 2023, compared to $265 million and $689 million during the quarter and nine months ended September 25, 2022. There were lower losses from the changes in the fair value of assets and liabilities related to deferred compensation plans during the quarter and nine months ended September 24, 2023 compared to the same periods in 2022.
Other (Expense) Income, Net
Other (expense) income, net, primarily includes earnings generated by equity method investees. Other expense, net was $6 million compared to other income, net of $39 million during the quarters ended September 24, 2023 and 2022. Other income, net was $30 million and $70 million during the nine months ended September 24, 2023 and 2022. Other (expense) income, net during the quarter and nine months ended September 24, 2023 includes lower earnings generated by our equity method investment in ULA due to lower launch volume and an increase in new product development costs.
Interest Expense
Interest expense during the quarter and nine months ended September 24, 2023 was $237 million and $662 million, compared to $145 million and $421 million during the quarter and nine months ended September 25, 2022. The increase in interest expense in 2023 resulted primarily from the issuance of senior unsecured notes in October 2022 and May 2023.
Non-Service FAS Pension Income (Expense)
Non-service FAS pension income was $111 million during the quarters ended September 24, 2023 and 2022. Non-service FAS pension income was $332 million compared to non-service FAS pension expense of $1.1 billion during the nine months ended September 24, 2023 and 2022. Non-service FAS pension expense for the nine months ended September 25, 2022 includes a noncash, non-operating pension settlement charge of $1.5 billion ($1.2 billion, or $4.33 per share, after-tax), related to the transfer of $4.3 billion of our gross defined benefit pension obligations and related plan assets to an insurance company during the second quarter of 2022.
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Other Non-operating Income (Expense), Net
Other non-operating income (expense), net primarily includes gains or losses related to changes in the fair value of early-stage company investments or gains or losses upon sale of these investments. Other non-operating income, net was $37 million compared to other non-operating expense, net of $26 million during the quarters ended September 24, 2023 and 2022. Other non-operating income, net was $69 million compared to other non-operating expense, net of $64 million during the nine months ended September 24, 2023 and 2022. Other non-operating income (expense), net for the quarter and nine months ended September 24, 2023 includes lower losses related to fair value adjustments of early-stage company investments and higher interest income compared to the same periods in 2022. See “Note 10 - Other” included in our Notes to Consolidated Financial Statements for additional information.
Income Tax Expense
Our effective income tax rates were 13.8% and 15.1% for the quarter and nine months ended September 24, 2023 and 15.3% and 14.9% for the quarter and nine months ended September 25, 2022. The rate for the third quarter of 2023 was lower than the third quarter of 2022 primarily due to additional research and development tax credits for prior years. The rates for all periods benefited from research and development tax credits, tax deductions for foreign derived intangible income and dividends paid to our defined contribution plans with an employee stock ownership plan feature.
Changes in U.S. (federal or state) or foreign tax laws and regulations, or their interpretation and application (including those with retroactive effect), such as 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. In addition to future changes in tax laws, the amount 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 the change in the amount or reevaluation of uncertain tax positions.
Beginning in 2022, the Tax Cuts and Jobs Act of 2017 eliminated the option to deduct research and development expenditures immediately in the year incurred and requires taxpayers to amortize such expenditures over five years for tax purposes. This provision is expected to increase our 2023 cash tax liability by approximately $575 million and our net deferred tax assets will increase by a similar amount. The actual impact on 2023 cash tax liability will depend on the amount of research and development expenses paid or incurred in 2023 among other factors. The cash tax impact will continue over the five-year amortization period but will decrease over the period and be immaterial by 2027.
We are regularly under audit or examination by tax authorities, including foreign tax authorities (including in, amongst others, Australia, Canada, India, Italy, Japan, Poland, and the United Kingdom). 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 $1.7 billion ($6.73 per share) and $5.1 billion ($19.97 per share) during the quarter and nine months ended September 24, 2023, compared to $1.8 billion ($6.71 per share) and $3.8 billion ($14.31 per share) during the quarter and nine months ended September 25, 2022. Net earnings and earnings per share for the quarter and nine months ended September 24, 2023 were affected by the factors mentioned above. Earnings per share also benefited from a net decrease of approximately 14.9 million and 13.8 million weighted average common shares outstanding during the quarter and nine months ended September 24, 2023, compared to the same periods in 2022. The reduction in weighted average common shares was a result of share repurchases, partially offset by share issuance 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 and thus are not included in management’s evaluation of performance of each segment. 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.
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Business segment operating profit excludes the FAS/CAS pension operating adjustment described below, a portion of corporate costs not considered allowable or allocable to contracts with the U.S. Government under the applicable U.S. Government cost accounting standards (CAS) or federal acquisition regulations (FAR), and other items not considered part of management’s evaluation of segment operating performance. See “Note 3 - Information on Business Segments – unallocated items”.
Sales and operating profit for each of our business segments were as follows (in millions):
Quarters Ended Nine Months Ended
September 24,
2023 September 25,
2022 September 24,
2023 September 25,
2022
Net sales
Aeronautics $ 6,717 $ 7,089 $ 19,861 $ 19,352
Missiles and Fire Control 2,939 2,831 8,082 8,030
Rotary and Mission Systems 4,121 3,781 11,528 11,345
Space 3,101 2,882 9,226 8,266
Total net sales $ 16,878 $ 16,583 $ 48,697 $ 46,993
Operating profit
Aeronautics $ 671 $ 759 $ 2,064 $ 2,051
Missiles and Fire Control 398 383 1,146 1,186
Rotary and Mission Systems 482 472 1,286 1,339
Space 259 304 851 823
Total business segment operating profit 1,810 1,918 5,347 5,399
Unallocated items
FAS/CAS pension operating adjustment 414 430 1,245 1,281
Intangible asset amortization expense (61) (62) (185) (186)
Other, net (121) (127) (193) (439)
Total unallocated items 232 241 867 656
Total consolidated operating profit $ 2,042 $ 2,159 $ 6,214 $ 6,055
Effective January 1, 2023, we no longer consider amortization expense related to purchased intangible assets when evaluating the operating performance of our business segments. This change has been applied to the accompanying amounts above, including the amounts for 2022. See “Note 1 - Basis of Presentation” included in our Notes to Consolidated Financial Statements for further information regarding the impact of this change on our current and prior period segment operating profit. We also included supplemental tables under the caption Pro Forma Business Segment Summary Operating Results in our earnings release included as exhibit 99.1 to our Current Report on Form 8-K filed January 24, 2023, which provide unaudited pro forma financial information reflecting the impact of the change in presentation as-if it had been applicable for the quarters and year to date periods in 2022 and 2021. The supplemental tables, the earnings release and the Current Report on Form 8-K are not, and shall not be deemed to be, incorporated by reference herein.
Our business segments’ results of operations include pension expense only as calculated under U.S. Government Cost Accounting Standards (CAS), which we refer to as CAS pension cost. We recover CAS pension and other postretirement benefit plan cost through the pricing of our products and services on U.S. Government contracts and, therefore, recognize CAS pension cost in each of our business segment’s net sales and cost of sales. Our consolidated financial statements must present pension and other postretirement benefit plan income calculated in accordance with Financial Accounting Standards (FAS) requirements under U.S. GAAP. The operating portion of the total FAS/CAS pension adjustment represents the difference between the service cost component of FAS pension income (expense) and total CAS pension cost. The non-service FAS pension income (expense) components are included in non-service FAS pension income (expense) in our consolidated statements of earnings. As a result, to the extent that CAS pension cost exceeds the service cost component of FAS pension income (expense) we have a favorable FAS/CAS pension operating adjustment.
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The total FAS/CAS pension adjustments, including the service and non-service cost components of FAS pension income (expense) for our qualified defined benefit pension plans, were as follows (in millions):
Quarters Ended Nine Months Ended
September 24,
2023 September 25,
2022 September 24,
2023 September 25,
2022
Total FAS income (expense) and CAS cost
FAS pension income (expense) $ 94 $ 91 $ 283 $ (1,148)
Less: CAS pension cost 431 450 1,294 1,349
Total FAS/CAS pension adjustment $ 525 $ 541 $ 1,577 $ 201
Service and non-service cost reconciliation
FAS pension service cost $ (17) $ (20) $ (49) $ (68)
Less: CAS pension cost 431 450 1,294 1,349
Total FAS/CAS pension operating adjustment 414 430 1,245 1,281
Non-service FAS pension income (expense) 111 111 332 (1,080)
Total FAS/CAS pension adjustment $ 525 $ 541 $ 1,577 $ 201
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 and variable considerations. Profit booking rates may increase during the performance of the contract if we successfully retire risks related to 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. For further discussion on fixed-price contracts, see “Note 10 - Other” included in our Notes to Consolidated Financial Statements.
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
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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.
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. Increases in the profit booking rates, typically referred to as favorable profit adjustments, 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 and are typically referred to as unfavorable profit adjustments. Increases or decreases in profit booking rates are recognized in the period they are determined 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, insurance recoveries and gains on sales of assets. Unfavorable items may include the adverse resolution of contractual matters; supply chain disruptions; restructuring charges (except for significant severance actions, which are excluded from segment operating results); reserves for disputes; certain asset impairments; and losses on sales of certain assets.
Our consolidated net profit booking rate adjustments increased segment operating profit by approximately $335 million and $1.1 billion during the quarter and nine months ended September 24, 2023 and $455 million and $1.3 billion during the quarter and nine months ended September 25, 2022.
We periodically experience performance issues and record losses for certain programs. For further discussion on programs at Aeronautics and RMS, see “Note 10 - Other” included in our Notes to Consolidated Financial Statements.
We have contracted with the Canadian Government for the Canadian Maritime Helicopter Program (CMHP) at our RMS business segment that provides for design, development, and production of CH-148 aircraft (the Original Equipment contract), which is a military variant of the S-92 helicopter, and for logistical support to the fleet (the In Service Support contract) over an extended time period. We are currently in discussions with the Canadian Government to potentially restructure certain contractual terms and conditions that may be beneficial to both parties. The program has experienced performance issues, including delays in the final aircraft deliveries from the original contract requirement, and the Royal Canadian Air Force’s flight hours have been less than originally anticipated, which has impacted program revenues and the recovery of our costs under this program. We have incurred significant costs and recognized the related sales, which are currently included in contract assets on the balance sheet. Such assets are recovered based on flight hours. Future sales and recovery of costs under the program are highly dependent upon achieving a certain number of flight hours, which are uncertain and dependent on aircraft availability and performance, and the availability of Canadian government resources. During the second quarter of 2023, due to increases in estimated costs for the production and lower than planned revenues for the logistical support program considering recent discussions with the customer and subsequent analysis, we recognized a loss of $100 million ($75 million, or $0.29 per share, after tax) on the program. Future performance issues, lower than forecast flight hours, or changes in our estimates due to the outcome of any restructuring discussions, including revised contract scope or customer requirements may further affect our ability to recover our costs, including the contract assets recognized on the balance sheet, or our assessment of the likelihood of cost recovery and may result in additional losses that could be material to our operating results. As of September 24, 2023, cumulative losses remained unchanged.
We also have a number of contracts with Türkish industry for the Türkish Utility Helicopter Program (TUHP), which anticipates co-production with Türkish industry for production of T70 helicopters for use in Türkiye, as well as the related provision of Türkish goods and services under buy-back or offset obligations, to include the future sales of helicopters built in Türkiye for sale globally. In 2020, the U.S. Government imposed certain sanctions on Türkish entities and persons that have affected our ability to perform under the TUHP contracts and we have provided force majeure notices under the affected contracts. The TUHP contracts may be negotiated to be restructured or terminated, either in whole or in part,
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during which, we could be at risk of recording a reach-forward loss in future periods. Additionally, we could elect to pursue other relief or remedies, which could result in a further reduction in sales, the imposition of penalties or assessment of damages, and increased unrecoverable costs, which could have an adverse effect on our financial results.
Our MFC business segment was previously awarded a competitively bid classified contract, which includes multiple phases of the program. We are currently performing on a phase which is primarily structured as cost-type. Additional phases are primarily fixed price and are not currently able to be awarded. If the additional phases are awarded at later dates, some of which could be within the next twelve months, we expect that those phases would be performed at a loss. We will continue to monitor the circumstances on the program and we may be required to recognize a reach-forward loss related to any additional phases at such time they become probable that they will be awarded. Any such losses could be material to our financial results.
Aeronautics
Summary operating results for our Aeronautics business segment were as follows (in millions):
Quarters Ended Nine Months Ended
September 24,
2023 September 25,
2022 September 24,
2023 September 25,
2022
Net sales $ 6,717 $ 7,089 $ 19,861 $ 19,352
Operating profit 671 759 2,064 2,051
Operating margin 10.0 % 10.7 % 10.4 % 10.6 %
Aeronautics’ net sales during the quarter ended September 24, 2023 decreased $372 million, or 5%, compared to the same period in 2022. The decrease was primarily attributable to lower net sales of $525 million for the F-35 program due to lower volume on production contracts and the recognition in the third quarter 2022 of $325 million of sales deferred from the second quarter of 2022 until additional contractual authorization and funding was received on the Lot 15 contract. This decrease was partially offset by higher net sales of $125 million on classified programs due to higher volume.
Aeronautics’ operating profit during the quarter ended September 24, 2023 decreased $88 million, or 12%, compared to the same period in 2022. The decrease was primarily attributable to lower operating profit of $115 million for the F-35 program due to lower volume and lower favorable profit adjustments on production contracts and the recognition of sales and associated operating profit in the third quarter of 2022 on the Lot 15 contract as described above. This decrease was partially offset by higher operating profit of $50 million on classified programs due to higher net favorable profit adjustments in 2023 and the absence in 2023 of unfavorable profit adjustments recorded in the third quarter of 2022. Total net profit booking rate adjustments were $80 million lower in the third quarter of 2023 compared to the same period in 2022.
Aeronautics’ net sales in the nine months ended September 24, 2023 increased $509 million, or 3%, compared to the same period in 2022. The increase was primarily attributable to higher net sales of $360 million on classified programs due to higher volume and higher net sales of $165 million for the F-16 program due to higher production volume. These increases were partially offset by lower net sales of $125 million for the F-35 program due to lower volume on production contracts partially offset by higher volume on sustainment and development contracts.
Aeronautics’ operating profit in the nine months ended September 24, 2023 was comparable to the same period in 2022. Operating profit increased $80 million on classified programs due to higher volume and the absence in 2023 of unfavorable profit adjustments recorded in the third quarter of 2022. This increase was offset by lower operating profit of $75 million for the F-22 program due to lower net favorable profit adjustments. Total net profit booking rate adjustments were $95 million lower in the nine months ended September 24, 2023 compared to the same period in 2022.
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Missiles and Fire Control
Summary operating results for our MFC business segment were as follows (in millions):
Quarters Ended Nine Months Ended
September 24,
2023 September 25,
2022 September 24,
2023 September 25,
2022
Net sales $ 2,939 $ 2,831 $ 8,082 $ 8,030
Operating profit 398 383 1,146 1,186
Operating margin 13.5 % 13.5 % 14.2 % 14.8 %
MFC’s net sales during the quarter ended September 24, 2023 increased $108 million, or 4%, compared to the same period in 2022. The increase was primarily attributable to higher net sales of $125 million for tactical and strike missile programs due to higher volume (Guided Multiple Launch Rocket Systems (GMLRS) and High Mobility Artillery Rocket System (HIMARS)). These increases were partially offset by lower net sales of $60 million for integrated air and missile defense programs due to lower volume (Patriot Advanced Capability-3 (PAC-3)).
MFC’s operating profit during the quarter ended September 24, 2023 increased $15 million, or 4%, compared to the same period in 2022. The increase was primarily attributable to higher operating profit of $10 million for sensors and global sustainment programs due to higher net favorable profit adjustments (Apache). Operating profit for integrated air and missile defense programs was comparable to the same period in 2022 due to lower favorable profit adjustments (PAC-3) in 2023 offset by the absence in 2023 of a $40 million unfavorable profit adjustment on the Advanced Radar Threat System Variant 2 (ARTS-V2) program in the third quarter of 2022. Total net profit booking rate adjustments were $15 million higher in the third quarter of 2023 compared to the same period in 2022.
MFC’s net sales in the nine months ended September 24, 2023 increased $52 million, or 1%, compared to the same period in 2022. The increase was primarily attributable to higher net sales of $85 million for tactical and strike missile programs due to higher volume (Precision Strike Missile (PrSM)), partially offset by lower net sales of $80 million for sensors and global sustainment programs due to the absence in 2023 of the impact of a favorable profit adjustment on an international program as a result of a requirements modification in 2022.
MFC’s operating profit in the nine months ended September 24, 2023 decreased $40 million, or 3%, compared to the same period in 2022. The decrease was primarily attributable to lower operating profit of $100 million for sensors and global sustainment programs due to the absence in 2023 of the favorable profit adjustment on an international program in 2022 as described above. This decrease was partially offset by higher operating profit of $50 million for integrated air and missile defense programs due to the absence in 2023 of a $40 million unfavorable profit adjustment on the ARTS-V2 program in the third quarter of 2022. Total net profit booking rate adjustments were approximately $65 million lower in the nine months ended September 24, 2023 compared to the same period in 2022.
Rotary and Mission Systems
Summary operating results for our RMS business segment were as follows (in millions):
Quarters Ended Nine Months Ended
September 24,
2023 September 25,
2022 September 24,
2023 September 25,
2022
Net sales $ 4,121 $ 3,781 $ 11,528 $ 11,345
Operating profit 482 472 1,286 1,339
Operating margin 11.7 % 12.5 % 11.2 % 11.8 %
RMS’ net sales during the quarter ended September 24, 2023 increased $340 million, or 9%, compared to the same period in 2022. The increase was primarily attributable to higher net sales of $235 million for IWSS programs due to new program ramp up (Defense of Guam, Indirect Fire Protection Capability High Energy Laser (IFPC-HEL) and TPY-4 programs) and higher volume (Aegis); and higher net sales of $60 million on C6IRSR (command, control, communications, computers, cyber, combat systems, intelligence, surveillance, and reconnaissance) programs due to higher volume.
RMS’ operating profit during the quarter ended September 24, 2023 increased $10 million, or 2%, compared to the same period in 2022. The increase was primarily attributable to higher operating profit of $50 million for IWSS programs due to higher favorable profit adjustments (Littoral Combat Ship (LCS)) and new program ramp up (Defense of Guam, IFPC-HEL and TPY-4 programs). This increase was partially offset by lower operating profit of $35 million for Sikorsky
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helicopter programs due to lower favorable profit adjustments (Combat Rescue Helicopter (CRH) and Black Hawk). Total net profit booking rate adjustments were $25 million lower in the third quarter of 2023 compared to the same period in 2022.
RMS’ net sales in the nine months ended September 24, 2023 increased $183 million, or 2%, compared to the same period in 2022. The increase was primarily attributable to higher net sales of $380 million for IWSS programs due to higher volume (Aegis) and new program ramp up (Defense of Guam and TPY-4 programs), partially offset by lower net sales of $190 million for Sikorsky helicopter programs due to lower production volume (Black Hawk).
RMS’ operating profit in the nine months ended September 24, 2023 decreased $53 million, or 4%, compared to the same period in 2022. The decrease was primarily attributable to lower operating profit of $160 million for Sikorsky helicopter programs due to an unfavorable profit adjustment of $100 million in the second quarter of 2023 on the CMHP as a result of increases in estimated costs and lower than planned revenues and lower production volume (Black Hawk).This decrease was partially offset by higher operating profit of $140 million for IWSS programs primarily due to the favorable profit adjustment of $65 million in second quarter of 2023 as a result of a positive resolution of a contractual matter on an international surveillance and control program, along with higher volume (Aegis) and higher favorable profit adjustments (LCS). Total net profit booking rate adjustments were $100 million lower in the nine months ended September 24, 2023 compared to the same period in 2022.
Space
Summary operating results for our Space business segment were as follows (in millions):
Quarters Ended Nine Months Ended
September 24,
2023 September 25,
2022 September 24,
2023 September 25,
2022
Net sales $ 3,101 $ 2,882 $ 9,226 $ 8,266
Operating profit 259 304 851 823
Operating margin 8.4 % 10.5 % 9.2 % 10.0 %
Space’s net sales during the quarter ended September 24, 2023 increased $219 million, or 8%, compared to the same period in 2022. The increase was primarily attributable to higher net sales of $135 million for strategic and missile defense programs due to higher volume (NGI development and FBM); higher net sales of $45 million for national security space programs due to higher volume (GPS III); and higher net sales of $40 million for commercial civil space programs due to higher volume (Orion).
Space’s operating profit during the quarter ended September 24, 2023 decreased $45 million, or 15%, compared to the same period in 2022. The decrease was primarily attributable to $35 million of lower equity earnings from ULA due to lower launch volume. Total net profit booking rate adjustments were $30 million lower in the third quarter of 2023 compared to the same period in 2022.
Spa ce’s net sales in the nine months ended September 24, 2023 increased $960 million, or 12%, compared to the same period in 2022. The increase was primarily attributable to higher net sales of $470 million for strategic and missile defense programs due to higher volume (NGI development and FBM); higher net sales of $335 million for national security space programs due to higher volume (GPS III, Transport Layer development and classified development programs); and higher net sales of $160 million for commercial civil space programs due to higher volume and higher favorable profit adjustments (Orion).
Space’s operating profit in the nine months ended September 24, 2023 increased $28 million, or 3%, compared to the same period in 2022. The increase was primarily attributable to higher operating profit of $80 million for national security space programs due to higher net favorable profit adjustments (classified programs and Next Generation Overhead Persistent Infrared (Next Gen OPIR)).This increase was partially offset by $65 million of lower equity earnings from ULA due to lower launch volume and an increase in new product development costs. Total net profit booking rate adjustments were $60 million higher in the nine months ended September 24, 2023 compared to the same period in 2022.
Total equity earnings (primarily ULA) represented approximately $15 million, or 6%, and $20 million, or 2%, of Space's operating profit during the quarter and nine months ended September 24, 2023, compared to approximately $50 million, or 16%, and $85 million, or 10%, during the quarter and nine months ended September 25, 2022.
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FINANCIAL CONDITION
Liquidity and Cash Flows
At September 24, 2023, we had cash and cash equivalents of $3.6 billion. Our principal source of liquidity is our cash from operations. However, we also have access to credit markets, if needed, for liquidity or general corporate purposes, including share repurchases. This access includes our $3.0 billion revolving credit facility or the ability to issue commercial paper, and letters of credit to support customer advance payments and for other trade finance purposes such as guaranteeing our performance on particular contracts. We believe our cash and cash equivalents, our expected cash flow generated from operations and our access to credit markets will be sufficient to meet our cash requirements and cash deployment plans over the next twelve months and beyond based on our current business plans.
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 from operations. We generally do not begin work on contracts until funding is appropriated by the customer. However, from time to time, we fund customer programs ourselves pending government appropriations. If we incur costs in excess of funds obligated on the contract or in advance of a contract award, this negatively affects our cash flows and 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 41% of the sales we recorded during the quarter ended September 24, 2023, 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 the timing of the costs incurred 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 and are invoiced regularly as costs are incurred. Our cash flows may be affected if the U.S. Government changes its payment policies. For example, the U.S. Government increased the progress payment rate applicable to us from 80% to 90% at the beginning of the COVID-19 pandemic. Effective July 2023, this policy was rescinded and all new contracts executed will revert back to the 80% progress payment rate. Due to our cash deployment practices, we do not anticipate a material impact to our cash flows as a result of this change. In addition, the U.S. Government from time to time withholds payments on certain of our billings based on contract terms or regulatory provisions. Ultimately, the impact of policy changes or withholding payments may delay the receipt of cash, but the cumulative amount of cash collected during the life of the contract should not vary. Additionally, during the COVID-19 pandemic, we accelerated payments to the supply chain with a focus on small and at-risk businesses. We will continue to evaluate the use of accelerated payments on an as needed basis.
We have a balanced cash deployment strategy to invest in our business and key technologies to provide our customers with enhanced capabilities, 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 and technologies through capital expenditures, independent research and development, and selective business acquisitions and investments.
We have returned cash to stockholders through dividends and share repurchases. In October 2023, the Board of Directors authorized a fourth quarter dividend payment of $3.15 per share, representing an increase of $0.15 per share over the prior quarterly dividend payment. The Board of Directors also authorized an increase of $6.0 billion to our share repurchase program in addition to the $7.0 billion remaining in authorization as of September 24, 2023. We currently expect that the authorization amount will be utilized for share repurchases through 2026. We expect to fund the repurchases through a combination of cash on hand and the issuance of debt. The stock repurchase program does not have an expiration date and may be amended or terminated by the Board of Directors at any time. The amount of shares ultimately purchased and the timing of purchases are at the discretion of management and subject to compliance with applicable law and regulation.
We continue to actively manage our debt levels, including maturities and interest rates. We also actively manage our pension obligations and expect to continue to opportunistically manage our pension liabilities through the purchase of
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group annuity contracts or other actions for portions of our outstanding defined benefit pension obligations using assets from the pension trust. See “Note 6 - Postretirement Benefit Plans” included in our Notes to Consolidated Financial Statements for additional information. Future pension risk transfer transactions could be significant and result in us making additional contributions to the pension trust and/or require us to recognize noncash, non-operating pension settlement charges in earnings in the applicable reporting period.
There were no material changes during the quarter or nine months ended September 24, 2023 to our contractual commitments as presented in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our 2022 Form 10-K that were outside the ordinary course of our business.
The following table provides a summary of our cash flow information followed by a discussion of the key elements (in millions):
Nine Months Ended
September 24,
2023 September 25,
2022
Cash and cash equivalents at beginning of year $ 2,547 $ 3,604
Operating activities
Net earnings 5,054 3,820
Noncash adjustments 835 2,090
Changes in working capital (232) (621)
Other, net (102) 585
Net cash provided by operating activities 5,555 5,874
Net cash used for investing activities (991) (981)
Net cash used for financing activities (3,560) (6,067)
Net change in cash and cash equivalents 1,004 (1,174)
Cash and cash equivalents at end of period $ 3,551 $ 2,430
Operating Activities
Net cash provided by operating activities during the nine months ended September 24, 2023 decreased $319 million compared to the same period in 2022. T he decrease was primarily due to the timing of federal tax payments.
Non-GAAP Financial Measure - Free Cash Flow
Free cash flow is a non-GAAP financial measure that we define as cash from operations less capital expenditures. Our capital expenditures are comprised of equipment and facilities infrastructure and information technology (inclusive of costs for the development or purchase of internal-use software that are capitalized). We use free cash flow to evaluate our business performance and overall liquidity, as well as a performance goal in our annual and long-term incentive plans. We believe free cash flow is a useful measure for investors because it represents the amount of cash generated from operations after reinvesting in the business and that may be available to return to stockholders and creditors (through dividends, stock repurchases and debt repayments) or available to fund acquisitions and other investments. The entire amount of free cash flow is not necessarily available for discretionary expenditures, however, because it does not account for certain mandatory expenditures, such as the repayment of maturing debt and pension contributions. While management believes that free cash flow as a non-GAAP financial measure may be useful in evaluating our financial performance, it should be considered supplemental to, and not a substitute for, financial information prepared in accordance with GAAP and may not be comparable to similarly titled measures used by other companies.
The following table reconciles net cash provided by operating activities to free cash flow (in millions):
Nine Months Ended
September 24,
2023 September 25,
2022
Cash from operations $ 5,555 $ 5,874
Capital expenditures (987) (977)
Free cash flow $ 4,568 $ 4,897
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Investing Activities
Net cash used for investing activities during the nine months ended September 24, 2023 was comparable to the same period in 2022. Capital expenditures totaled $987 million and $977 million during the nine months ended September 24, 2023 and September 25, 2022. The majority of our capital expenditures are 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 was $3.6 billion during the nine months ended September 24, 2023, compared to $6.1 billion during the same period in 2022.
During the nine months ended September 24, 2023 and September 25, 2022, we paid dividends totaling $2.3 billion ($9.00 per share) and $2.3 billion ($8.40 per share).
During the nine months ended September 24, 2023, we paid $3.0 billion to repurchase 6.7 million shares of our common stock. See “Note 9 - Stockholders’ Equity” included in our Notes to Consolidated Financial Statements for additional information. During the nine months ended September 25, 2022, we paid $3.7 billion to repurchase 11.1 million shares of our common stock.
During the nine months ended September 24, 2023, we received net proceeds of $2.0 billion from issuance of senior unsecured notes. See “Note 10 - Other” included in our Notes to Consolidated Financial Statements for additional information. During the nine months ended September 25, 2022, we received net proceeds of $2.3 billion from issuance of senior unsecured notes and used the net proceeds from the offering to redeem all of the outstanding $500 million Notes due 2023, $750 million Notes due 2025 and used the remaining balance of the net proceeds to redeem $1.0 billion of our
outstanding $2.0 billion Notes due 2026.
During the nine months ended September 24, 2023, we repaid $115 million of long-term notes with a fixed interest rate of 7.00% according to their scheduled maturities.
Capital Resources
At September 24, 2023, we held cash and cash equivalents of $3.6 billion that was generally available to fund ordinary business operations without significant legal, regulatory or other restrictions.
At September 24, 2023, we had a $3.0 billion revolving credit facility (the Revolving Credit Facility) with various banks that is available for general corporate purposes including supporting commercial paper borrowings. Effective August 24, 2023, we extended the expiration date of the Revolving Credit Facility from August 24, 2027 to August 24, 2028. We may request and the banks may grant, at their discretion, an increase in the borrowing capacity under the Revolving Credit Facility of up to an additional $500 million. There were no borrowings outstanding under the Revolving Credit Facility at September 24, 2023.
We have agreements in place with financial institutions to provide for the issuance of commercial paper. The outstanding balance of commercial paper can fluctuate daily and the amount outstanding during the period may be greater than or less than the amount reported at the end of the period. There were no commercial paper borrowings outstanding as of September 24, 2023 and December 31, 2022. We may, as conditions warrant, from time to time issue commercial paper backed by our Revolving Credit Facility to manage the timing of cash flows. However, depending on market conditions, commercial paper may not be available on favorable terms or at all.
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Our total outstanding short-term and long-term debt, net of unamortized discounts and issuance costs was $17.4 billion as of September 24, 2023 and is in the form of publicly-issued notes that bear interest at fixed rates. We use variable interest rate swaps to convert a portion of the fixed rate borrowings to variable rate borrowings, see “Note 8 – Fair Value Measurements” included in our Notes to Consolidated Financial Statements for additional information. As of September 24, 2023, 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 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.
OTHER MATTERS
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 seven international partner countries and nine Foreign Military Sales (FMS) customers; as well as interest from other countries. We continue to see strong international demand for the F-35. The Government of Canada announced in January 2023 their commitment to purchase 88 F-35 aircraft. In February 2023, the Government of Singapore announced its intent to exercise an option to purchase an additional eight F-35 aircraft, increasing its total quantity to 12. In September 2023, the Israel Defense Ministry submitted an official letter of request to advance Israel’s procurement of a third F-35 squadron, increasing their total quantity of aircraft from 50 to 75. Also in September 2023, the U.S. Department of State formally approved the sale of up to 25 more F-35s to South Korea, beyond the currently approved purchase of 40 aircraft.
During the third quarter of 2023, we delivered 30 aircraft, bringing year-to-date 2023 deliveries to 80, and ended the quarter with a backlog of 391 aircraft. Since program inception through the third quarter of 2023, we have delivered 974 production F-35 aircraft to U.S. and international customers, including 703 F-35A variants, 191 F-35B variants, and 80 F-35C variants, demonstrating the F-35 program’s continued progress and longevity.
During the third quarter of 2023, we updated our F-35 Technology Refresh 3 (“TR-3”) schedule projections and we currently anticipate delivering the first TR-3 aircraft between April and June 2024. As a result, we now expect to deliver 97 aircraft in 2023 (all in the TR-2 configuration), which we do not currently anticipate will impact our 2023 financial outlook. We are producing F-35s at a rate of 156 per year and expect to continue at that pace while simultaneously working to finalize TR-3 software development and testing. Additionally, we remain focused on receiving the necessary hardware from our suppliers to deliver this critical combat capability for the F-35.
Given the size and complexity of the F-35 program, we anticipate that there will be continual reviews related to aircraft performance, program, and delivery schedule, cost, and requirements as part of the DoD, Congressional, and international countries’ oversight, and budgeting processes. Current program challenges include our and our suppliers’ performance, software development (including, in particular, software maturation related to the TR-3 configuration), execution of future flight tests and findings resulting from testing and operating the aircraft, the level of cost associated with life cycle operations, sustainment and potential contractual obligations, inflation-related cost pressures, and the ability to improve affordability.
Contingencies
See “Note 7 - Legal Proceedings and Contingencies” included in our Notes to Consolidated Financial Statements for information regarding our contingent obligations, including off-balance sheet arrangements.
Critical Accounting Policies
There have been no significant changes to the critical accounting policies disclosed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2022 Form 10-K.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.