NOTE 1 – BASIS OF PRESENTATION

We have prepared the unaudited condensed consolidated financial statements in this Form 10-Q in accordance with accounting principles generally accepted in the United States of America (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. We have continued to follow the accounting policies disclosed in the consolidated financial statements included in our 2008 Form 10-K filed with the United States Securities and Exchange Commission (SEC).

It is our practice to close our books and records on the Sunday prior to the end of the calendar quarter to align our financial closing with our business processes. The interim financial statements and tables of financial information included herein are labeled based on that convention. This practice only affects interim periods, as our fiscal year ends on December 31.

The interim financial information in this Form 10-Q reflects all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of our results of operations for the interim periods. The results of operations for the nine months ended September 27, 2009 are not necessarily indicative of results to be expected for the full year.

We have reclassified certain amounts for the prior period to conform to the 2009 presentation. For the nine months ended September 28, 2008, we reclassified an $18 million reduction in cash from operating activities to “Effect of exchange rate changes on cash and cash equivalents” on our Statement of Cash Flows. The reclassification related to the effect of exchange rate changes on cash held in foreign currencies.

We have evaluated subsequent events through the time of filing this Form 10-Q with the SEC on October 22, 2009. No material subsequent events have occurred since September 27, 2009 that required recognition or disclosure in these financial statements.

NOTE 2 – EARNINGS PER SHARE

We compute basic and diluted per share amounts based on net earnings for the periods presented. We use the weighted average number of common shares outstanding during the period to calculate basic earnings per share. The weighted average number of common shares used in our calculation of diluted per share amounts includes the dilutive effects of stock options and restricted stock units based on the treasury stock method, and shares related to our convertible debentures discussed below.

Unless otherwise noted, we present all per share amounts cited in these financial statements on a “per diluted share” basis.

 

The calculations of basic and diluted earnings per share are as follows:

 

		Quarter Ended						Nine Months Ended
(In millions, except per share data)		September 27, 2009			September 28, 2008			September 27, 2009			September 28, 2008
Net earnings for basic and diluted computations		$	797		$	782		$	2,197		$	2,394
Weighted average common shares outstanding:
Average number of common shares outstanding for basic computations			381.4			397.4			387.2			401.1
Dilutive stock options, restricted stock units and convertible securities			4.1			9.7			4.1			10.0
Average number of common shares outstanding for diluted computations			385.5			407.1			391.3			411.1
Earnings per common share
Basic		$	2.09		$	1.97		$	5.67		$	5.97
Diluted		$	2.07		$	1.92		$	5.61		$	5.82

On June 26, 2008, our Board of Directors authorized and we announced the planned redemption of any and all of our $1.0 billion in original principal amount of floating rate convertible debentures that remained outstanding on August 15, 2008. In August 2008, all of the debentures were delivered for conversion or were redeemed (see Note 8 under the caption “Long-term Debt”). The accounting standard for earnings per share required an assumption that shares would be used to pay the conversion obligations in excess of the accreted principal amount and that those shares would be included in our calculation of weighted average common shares outstanding for the diluted earnings per share computation up to the date the convertible securities were converted. The number of shares included in the computation for the quarter and nine months ended September 28, 2008 did not have a material impact on earnings per share.

NOTE 3 – INFORMATION ON BUSINESS SEGMENTS

We operate in four principal business segments: Electronic Systems, Information Systems & Global Services (IS&GS), Aeronautics, and Space Systems. We organize our business segments based on the nature of the products and services offered.

In the following table, total operating profit of the business segments is reconciled to the corresponding consolidated amount. The reconciling item “Unallocated Corporate income (expense), net” includes the FAS/CAS pension adjustment (see discussion below), costs for certain stock-based compensation programs (including stock-based compensation costs for stock options and restricted stock units), the effects of items not considered part of management’s evaluation of segment operating performance, Corporate costs not allocated to the operating segments, and other miscellaneous Corporate activities. Since the activities of the investees in which certain business segments hold equity interests are closely aligned with the operations of those segments, the equity earnings (losses) from those investees are included in the operating profit of the respective segments.

The FAS/CAS pension adjustment represents the difference between pension expense or income calculated for financial reporting purposes under GAAP, and pension costs calculated and funded in accordance with U.S. Government Cost Accounting Standards (CAS), which are reflected in our business segment results. CAS is a major factor in determining our pension funding requirements, and governs the extent to which pension costs can be allocated to and recovered on government contracts. The CAS expense is recovered through the pricing of our products and services on U.S. Government contracts and, therefore, recognized in segment net sales. The results of operations of our segments only include pension expense as determined and funded in accordance with CAS rules.

Transactions between segments are negotiated and accounted for under terms and conditions similar to other government and commercial contracts; however, these intercompany transactions are eliminated in consolidation and for purposes of the presentation of net sales in the related table that follows.

Selected Financial Data by Business Segment

 

		Quarter Ended								Nine Months Ended
(In millions)		September 27, 2009				September 28, 2008				September 27, 2009				September 28, 2008
Net sales
Electronic Systems		$	2,922			$	2,802			$	8,911			$	8,686
Information Systems & Global Services			2,977				2,950				8,756				8,312
Aeronautics			3,084				2,917				8,951				8,608
Space Systems			2,073				1,908				6,047				5,993
Total		$	11,056			$	10,577			$	32,665			$	31,599
Operating profit
Electronic Systems		$	389			$	364			$	1,185			$	1,139
Information Systems & Global Services			244				267				734				769
Aeronautics			397				375				1,151				1,064
Space Systems			236				244				672				743
Total business segments			1,266				1,250				3,742				3,715
Unallocated Corporate income (expense), net			(181	)			(8	)			(517	)			68
Total		$	1,085			$	1,242			$	3,225			$	3,783
Intersegment revenue
Electronic Systems		$	214			$	157			$	592			$	443
Information Systems & Global Services			247				229				737				687
Aeronautics			53				40				152				111
Space Systems			28				37				95				104
Total business segments		$	542			$	463			$	1,576			$	1,345
(In millions)										September 27, 2009				December 31, 2008
Assets
Electronic Systems										$	9,129			$	8,515
Information Systems & Global Services											7,547				7,593
Aeronautics											4,366				3,521
Space Systems											2,989				2,908
Total business segments											24,031				22,537
Corporate activities (1)											11,711				10,902
Total										$	35,742			$	33,439

 

(1)	Assets primarily include cash and cash equivalents, short-term investments, deferred income taxes, the prepaid pension asset, the deferred environmental asset, and investments held in a Rabbi Trust.

NOTE 4 – INVENTORIES

 

(In millions)		September 27, 2009				December 31, 2008
Work-in-process, primarily related to long-term contracts and programs in progress		$	5,791			$	4,631
Less: customer advances and progress payments			(4,022	)			(3,396	)
			1,769				1,235
Other inventories			310				667
		$	2,079			$	1,902

NOTE 5 – POSTRETIREMENT BENEFIT PLANS

The net pension cost and the net postretirement benefit cost related to our qualified defined benefit pension plans and our retiree medical and life insurance plans include the following components:

 

		Quarter Ended								Nine Months Ended
(In millions)		September 27, 2009				September 28, 2008				September 27, 2009				September 28, 2008
Qualified defined benefit pension plans
Service cost		$	217			$	206			$	652			$	617
Interest cost			453				436				1,359				1,306
Expected return on plan assets			(507	)			(546	)			(1,521	)			(1,637	)
Amortization of prior service cost			20				20				60				60
Recognized net actuarial losses			76				—				227				1
Total net pension expense		$	259			$	116			$	777			$	347
Retiree medical and life insurance plans
Service cost		$	8			$	11			$	26			$	33
Interest cost			42				45				124				135
Expected return on plan assets			(26	)			(38	)			(80	)			(115	)
Amortization of prior service cost			(6	)			(7	)			(18	)			(19	)
Recognized net actuarial losses			10				—				32				1
Total net postretirement expense		$	28			$	11			$	84			$	35

In 2008, we made discretionary prepayments totaling $109 million related to our qualified defined benefit pension plans and $120 million related to our retiree medical and life insurance plans. These prepayments reduced our funding requirements for 2009. We funded $2 million in discretionary contributions to our qualified defined benefit pension plans during the quarter and nine months ended September 27, 2009. The remaining amount of required funding in 2009 is less than $5 million. We plan to review options for further discretionary contributions in 2009, and anticipate making a discretionary contribution of at least $1.0 billion to our defined benefit plans’ trust in the fourth quarter.

NOTE 6 – LEGAL PROCEEDINGS AND CONTINGENCIES

We are a party to or have property subject to litigation and other proceedings, including matters arising under provisions relating to the protection of the environment. We believe the probability is remote that the outcome of these matters will have a material adverse effect on the Corporation as a whole. We cannot predict the outcome of legal proceedings with certainty. These matters include the following items which have been previously reported.

 

Legal Proceedings

On June 24, 2009, the U.K. Ministry of Defence (MoD) sent us a letter declaring that we were in default on the “Soothsayer” contract under which we were providing electronic warfare equipment to the British military. The total value of the contract is UK £144 million, of which UK £39 million has been paid to date (representing approximately US $230 million and US $62 million, based on the exchange rate as of September 27, 2009). The MoD has demanded repayment of amounts paid under the contract, liquidated damages of UK £2 million (representing approximately US $3 million based on the exchange rate as of September 27, 2009), interest on those amounts, and has reserved the right to collect any excess future re-procurement costs. We dispute the MoD’s position and plan to proceed to alternative dispute resolution pursuant to the contract terms and to seek damages for wrongful termination of the contract (including costs incurred but not paid).

On April 24, 2009, we filed a declaratory judgment action against the N.Y. Metropolitan Transportation Authority and its Capital Construction Company (collectively, the MTA) asking the U.S. District Court for the Southern District of N.Y. to find that the MTA is in material breach of our agreement based on the MTA’s failure to provide access to sites where work must be performed and the customer-furnished equipment necessary to complete the contract. The contract provides for the design and installation of an integrated electronic security system for the MTA and has a total value of $323 million, of which $241 million has been paid to date. The MTA filed an answer and counterclaim on May 26, 2009, alleging that we breached the contract, and subsequently terminated the contract for alleged default. The MTA is seeking monetary damages and other relief under the contract, including the cost to complete the contract and potential re-procurement costs. We dispute the MTA’s allegations and are defending against them. On July 2, 2009, the sureties under the performance bond that we posted for the contract filed their own declaratory judgment action seeking to be excused from performing for the MTA (noting that they were unable to conclude that we were in material default under the contract) or, in the alternative, seeking indemnification from us. On July 7, 2009, we filed an amended complaint against the MTA adding claims for wrongful termination and for breach of contract damages (including costs incurred but not paid). The MTA has filed an amended counterclaim. Discovery is proceeding in the action.

On November 30, 2007, the Department of Justice (DoJ) filed a complaint in partial intervention in a lawsuit filed under the qui tam provisions of the Civil False Claims Act in the U.S. District Court for the Northern District of Texas, United States ex rel. Becker and Spencer v. Lockheed Martin Corporation et al., alleging that we should have known that a subcontractor falsified and inflated invoices submitted to us that were passed through to the government. We dispute the allegations and are defending against them.

On February 22, 2007, we received a subpoena issued by a grand jury in the United States District Court for the District of Columbia. The subpoena requests documents related to our participation in a competition conducted in 2004-2005 by the National Archives and Records Administration for a $3 million contract to provide electronic document system support services. We cooperated with the investigation. On October 5, 2009, we received notice from the Department of Justice Antitrust Division that the grand jury investigation has been closed without charges being filed.

On September 11, 2006, we and Lockheed Martin Investment Management Company (LMIMCo), our wholly-owned subsidiary, were named as defendants in a lawsuit filed in the U.S. District Court for the Southern District of Illinois, seeking to represent a class of purportedly similarly situated participants and beneficiaries in our Salaried Savings Plan and the Hourly Savings Plan (the Plans). Plaintiffs allege that we or LMIMCo caused the Plans to pay expenses that were higher than reasonable by, among other actions, permitting service providers of the Plans to engage in revenue sharing, paying investment management fees for the company stock funds, and causing the company stock funds to hold cash for liquidity, thus reducing the return on those funds. The plaintiffs further allege that we or LMIMCo failed to disclose information appropriately relating to the fees associated with managing the Plans. In August 2008, plaintiffs filed an amended complaint, adding allegations that we or LMIMCo breached fiduciary duties under ERISA by providing inadequate disclosures with respect to the Stable Value Fund offered under our 401(k) plans. In April 2009, the Judge dismissed the plaintiffs’ claims that were based on revenue sharing but let stand the claims about the company stock funds, the Stable Value Fund, and the overall fees paid by the plans. The Judge also certified a class for each plan for the claims concerning the Stable Value Fund and the overall fees paid by the plans. We are appealing that order. We dispute the allegations and are defending against them.

On February 6, 2004, we submitted a certified contract claim to the United States requesting contractual indemnity for remediation and litigation costs (past and future) related to our former facility in Redlands, California. We submitted the claim consistent with a claim sponsorship agreement with The Boeing Company (Boeing), executed in 2001, in Boeing’s role as the prime contractor on the Short Range Attack Missile (SRAM) program. The contract for the SRAM program, which formed a significant portion of our work at the Redlands facility, had special contractual indemnities from the U.S. Air Force, as authorized by Public Law 85-804. On August 31, 2004, the United States denied the claim. Our appeal of that decision is pending with the Armed Services Board of Contract Appeals.

On August 28, 2003, the DoJ filed complaints in partial intervention in two lawsuits filed under the qui tam provisions of the Civil False Claims Act in the United States District Court for the Western District of Kentucky, United States ex rel. Natural Resources Defense Council, et al., v. Lockheed Martin Corporation, et al., and United States ex rel. John D. Tillson v. Lockheed Martin Energy Systems, Inc., et al. The DoJ alleges that we committed violations of the Resource Conservation and Recovery Act at the Paducah Gaseous Diffusion Plant by not properly handling, storing, and transporting hazardous waste and that we violated the False Claims Act by misleading Department of Energy officials and state regulators about the nature and extent of environmental noncompliance at the plant. We dispute the allegations and are defending against them.

As described in the “Environmental Matters” discussion below, we are subject to federal and state requirements for protection of the environment, including those for discharge of hazardous materials and remediation of contaminated sites. As a result, we are a party to or have property subject to various other lawsuits or proceedings involving environmental matters and remediation obligations.

We have been in litigation with certain residents of Redlands, California since 1997 before the California Superior Court for San Bernardino County regarding allegations of personal injury, property damage, and other tort claims on behalf of individuals arising from our alleged contribution to regional groundwater contamination. On July 11, 2006, the California Court of Appeal dismissed the plaintiffs’ punitive damages claim. On September 23, 2008, the trial court dismissed the remaining first tier plaintiffs, ending the first round of individual trials. The first tier plaintiffs are pursuing their appellate remedies, and opposing counsel has asked the trial court to consider procedures for the litigation of the next round of individual plaintiffs.

Environmental Matters

We are involved in environmental proceedings and potential proceedings relating to soil and groundwater contamination, disposal of hazardous waste, and other environmental matters at several of our current or former facilities. Environmental cleanup activities usually span several years, which make estimating liabilities a matter of judgment because of such factors as changing remediation technologies, assessments of the extent of contamination, and continually evolving regulatory environmental standards. We consider these and other factors in estimates of the timing and amount of any future costs that may be required for remediation actions, which results in the calculation of a range of estimates for a particular environmental site. We record a liability for the amount within the range which we determine to be our best estimate of the cost of remediation or, in cases where no amount within the range is better than another, we record an amount at the low end of the range. We do not discount the recorded liabilities, as the amount and timing of future cash payments are not fixed or cannot be reliably determined.

We perform quarterly reviews of environmental remediation sites and record liabilities and assets in the period it becomes probable that a liability has been incurred and the amounts can be reasonably estimated. At September 27, 2009 and December 31, 2008, the aggregate amount of liabilities recorded relative to environmental matters was $862 million and $809 million. Of those amounts, $747 million and $694 million were recorded in other liabilities on the Balance Sheet, with the remainder recorded in other current liabilities. A portion of environmental costs is eligible for future recovery in the pricing of our products and services in U.S. Government contracts. We have recorded assets totaling $726 million and $683 million at September 27, 2009 and December 31, 2008 for the estimated future recovery of these costs, as we consider the recovery probable based on government contracting regulations and our history of receiving reimbursement for such costs. Of those amounts, $628 million and $585 million were recorded in other assets on the Balance Sheet, with the remainder recorded in other current assets. Amounts allocated to our commercial businesses or determined to be unallowable for pricing under U.S. Government contracts are expensed through cost of sales.

We cannot reasonably determine the extent of our financial exposure in all cases at this time. There are a number of former operating facilities which we are monitoring or investigating for potential future 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). We also are pursuing claims for contribution to site cleanup costs against other potentially responsible parties (PRPs), including the U.S. Government.

We are conducting remediation activities under various consent decrees and orders relating to soil and groundwater contamination at certain sites of former operations. Under agreements related to certain of our sites, the U.S. Government reimburses us an amount equal to approximately 50% of expenditures for certain remediation activities in its capacity as a PRP under the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA).

Letters of Credit and Other Arrangements

We have entered into standby letter of credit agreements, surety bonds and other arrangements with financial institutions and other third parties primarily relating to advances received from customers and/or the guarantee of future performance on certain contracts. We have total outstanding letters of credit, surety bonds and other arrangements aggregating $3.0 billion and $3.1 billion at September 27, 2009 and December 31, 2008. Letters of credit and surety bonds are generally available for draw down in the event we do not perform.

Investment in United Launch Alliance

In connection with the closing of the transaction to form United Launch Alliance, LLC (ULA) on December 1, 2006, we and Boeing each committed to providing up to $25 million in additional capital contributions and $200 million in other financial support to ULA, as required. The non-capital financial support is required to be made in the form of a revolving credit facility between us and ULA or guarantees of ULA financing with third parties, in either case to the extent necessary for ULA to meet its working capital needs. We have agreed to provide this support for at least five years from the closing date of the transaction, and would expect to fund our requirements with cash on hand. To satisfy our non-capital financial support commitment, we and Boeing put into place at closing a revolving credit agreement with ULA, under which no amounts have been drawn.

 

As of September 27, 2009, we and Boeing each had provided the $25 million of funding to ULA under the additional capital contribution commitment. Of that amount, $22 million was contributed in the second quarter of 2009, prior to which we each received a dividend from ULA in a like amount. Other than the $22 million contribution, we did not provide further funding to ULA during the first nine months of 2009.

In the fourth quarter of 2008, we and Boeing each received a $100 million dividend payment. Prior to distribution of that dividend, we, Boeing and ULA entered into an agreement whereby, if ULA does not have sufficient cash resources and/or credit capacity to make payments under the inventory supply agreement it has with Boeing, both we and Boeing would provide to ULA, in the form of an additional capital contribution, the level of funding required for ULA to make such payments. Such capital contributions would not exceed the aggregate amount of the dividends we received through June 1, 2009, which totaled $122 million. We currently believe that ULA will have sufficient operating cash flows and credit capacity to meet its obligations such that we would not be required to make a contribution under this agreement.

In addition, both we and Boeing have cross-indemnified ULA related to certain financial support arrangements (e.g., letters of credit, surety bonds, or foreign exchange contracts provided by either party) and guarantees by us and Boeing of the performance and financial obligations of ULA under certain launch service contracts. We believe ULA will be able to fully perform its obligations, as it has done through September 27, 2009, and that it will not be necessary to make payments under the cross-indemnities.

NOTE 7 – FAIR VALUE MEASUREMENTS

The accounting standard for fair value measurements defines fair value, establishes a market-based framework or hierarchy for measuring fair value, and expands disclosures about fair value measurements. The standard is applicable whenever assets and liabilities are measured at fair value.

The fair value hierarchy established in the standard prioritizes the inputs used in valuation techniques into three levels as follows:

 

•

Level 1 – Observable inputs – quoted prices in active markets for identical assets and liabilities;

 

•

Level 2 – Observable inputs other than the quoted prices in active markets for identical assets and liabilities – includes quoted prices for similar instruments, quoted prices for identical or similar instruments in inactive markets, and amounts derived from valuation models where all significant inputs are observable in active markets; and

 

•

Level 3 – Unobservable inputs – includes amounts derived from valuation models where one or more significant inputs are unobservable and require us to develop relevant assumptions. At September 27, 2009, we have no assets or liabilities that are categorized as Level 3. During 2009, we had no assets or liabilities that were transferred in or out of the Level 3 category.

 

The following table presents assets and liabilities measured and recorded at fair value on our Balance Sheet on a recurring basis and their level within the fair value hierarchy as of September 27, 2009:

 

(In millions)		Level 1			Level 2			Balance as of September 27, 2009
Assets
Equity securities(a)		$	260		$	—		$	260
Mutual funds(a)			53			—			53
U.S. Government securities(b)			—			499			499
Corporate debt securities(b)			—			94			94
U.S. Government-sponsored enterprise securities(b)			—			61			61
Other securities(b)			—			36			36
Derivative assets(c)			—			36			36
Total assets		$	313		$	726		$	1,039
Derivative liabilities(c)			—			21			21
Net assets		$	313		$	705		$	1,018

 

(a)	Equity securities and interests in mutual funds are valued using quoted market prices.

(b)	U.S. Government securities, corporate debt securities, U.S. Government-sponsored enterprise securities, and other securities are valued based on inputs other than quoted prices that are observable for the asset (e.g., interest rates and yield curves observable at commonly quoted intervals).

(c)	Derivative assets and liabilities relate to foreign currency exchange contracts and are valued based on observable market prices, but are not exchanged in an active market. See Note 8 under the caption “Derivative Financial Instruments” for further information related to our derivative instruments.

We maintain a Rabbi Trust which includes investments to fund certain of our non-qualified deferred compensation plans. Investments in the trust are classified as trading securities and, accordingly, changes in their fair values are recorded in other non-operating income (expense), net. As of September 27, 2009, investments in the trust totaled $548 million and are included within the investment securities categories listed in the table above. Our net unrealized gains on the investments in the trust were $36 million and $98 million for the quarter and nine months ended September 27, 2009.

At September 27, 2009, the estimated fair values of our long-term debt instruments aggregated $4,919 million, compared with a carrying amount of $4,144 million, excluding the $339 million unamortized discount. The fair values were estimated based on quoted market prices of debt with terms and due dates similar to our long-term debt instruments. Our cash equivalents include highly liquid instruments with original maturities of 90 days or less. Due to the short maturity of these instruments, the carrying amount on our Balance Sheet approximates fair value.

As of September 27, 2009, our non-financial assets and liabilities that are recorded at fair value on a nonrecurring basis were not material.

NOTE 8 – OTHER

Matters Included in Earnings

In the third quarter of 2009, the IRS examination of our U.S. Federal Income Tax Returns for the years 2005-2007 was resolved and settled. As a result, we recognized additional tax benefits and reduced our income tax expense for the third quarter by $58 million ($0.15 per share), including related interest. This reduction in income tax expense reduced our effective income tax rate by 5.4% and 1.9% for the quarter and nine months ended September 27, 2009.

In the third quarter of 2008, we recognized, net of state income taxes, a gain of $44 million in other income (expense), net representing a portion of the deferred net gain recorded in connection with the transaction to sell our ownership interests in Lockheed Khrunichev Energia International, Inc. (LKEI) and International Launch Services, Inc. (ILS) in 2006. The gain increased net earnings by $28 million ($0.07 per share). In the first quarter of 2008, we recognized, net of state income taxes, $16 million of the deferred net gain from the LKEI and ILS transaction, which increased net earnings by $10 million ($0.02 per share).

In the second quarter of 2008, we recognized, net of state income taxes, $85 million in other income (expense), net due to the elimination of reserves related to various land sales in California. Reserves were originally recorded at the time of each land sale in 2007 and prior years based on the U.S. Government’s assertion that a significant portion of the sale proceeds should be allocated to the buildings and improvements on the properties, thereby giving the U.S. Government the right to share in the gains associated with the land sales. At the time the land sales occurred, we believed the value of the properties sold was attributable to the land versus the buildings and improvements. The dispute ultimately went to trial with the Armed Services Board of Contract Appeals (ASBCA), subsequent to which the ASBCA determined that our accounting for the land sales was in accordance with the Federal Acquisition Regulation and CAS. We reached a settlement with the U.S. Government in the second quarter of 2008, and the previously recorded reserves were no longer required. Resolution of this matter increased our net earnings in the second quarter by $56 million ($0.14 per share).

Long-term Debt

On June 26, 2008, our Board of Directors authorized and we announced the planned redemption of any and all of our $1.0 billion in original principal amount of floating rate convertible debentures that remained outstanding on August 15, 2008. As of August 15, 2008, all of the debentures had been delivered for conversion or were redeemed. The aggregate amount paid in cash subsequent to conversion of the debentures was $1.0 billion, representing the principal amount of the debentures relative to our conversion obligations, which was equal to the original principal amount of the debentures. In addition, the conversion rate for the debentures from the time of our announcement in June 2008 through August 15, 2008 was 13.7998 shares of common stock for each $1,000 in original principal amount of debentures, equating to a conversion price of $72.46. The conversion obligations in excess of the principal amount, computed based on the closing price of our common stock over the cash settlement averaging period as defined in the indenture, totaled $571 million, and resulted in the issuance of 5.0 million shares of our common stock. The issuance of the common shares for the conversion obligations was recognized in stockholders’ equity as a $5 million increase to common stock and a corresponding decrease to additional paid-in capital. Also, deferred tax liabilities of $69 million attributable to interest deductions associated with the debentures have been credited to additional paid-in capital due to their conversion.

In the first quarter of 2008, we issued $500 million of long-term notes. The notes have a fixed coupon interest rate of 4.12% and are due in 2013.

Stockholders’ Equity

Share Repurchase Program

We used cash to repurchase shares of our common stock as follows:

 

•

In the first nine months of 2009, $1,362 million to repurchase 18.3 million common shares that were executed and settled during the nine-month period; and

 

•

In the first nine months of 2008, $2,338 million to repurchase 22.1 million common shares that were executed and settled during the nine-month period, and an additional $18 million for 0.2 million common shares purchased in September 2008 that were settled in October 2008.

As we repurchase common shares under our share repurchase program, we reduce common stock for the $1 of par value of the shares repurchased, with the remainder of the 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 of purchase price over par value as a reduction of retained earnings.

Our share repurchase program provides for the repurchase of shares of our common stock from time-to-time at management’s discretion. In September 2009, our Board authorized the repurchase of an additional 20.0 million shares, bringing the total authorized for repurchase under the program to 178.0 million. As of September 27, 2009, we had repurchased a total of 142.6 million shares under the program, and there remained approximately 35.4 million shares that may be repurchased in the future.

Dividends

During the first nine months of 2009, we declared and paid quarterly dividends totaling $668 million ($0.57 per share per quarter). We also declared our fourth quarter 2009 dividend, which was increased to $0.63 per share. The fourth quarter dividend totaled $240 million and was recorded as a current liability and a reduction of retained earnings. This dividend will be paid in December 2009. In the first nine months of 2008, we declared and paid dividends totaling $510 million ($0.42 per share per quarter).

Comprehensive Income

The components of comprehensive income for the three months and nine months ended September 27, 2009 and September 28, 2008 consisted of the following:

 

		Quarter Ended								Nine Months Ended
(In millions)		September 27, 2009				September 28, 2008				September 27, 2009			September 28, 2008
Net earnings		$	797			$	782			$	2,197		$	2,394
Other comprehensive income (loss)			(10	)			(17	)			30			18
Comprehensive income		$	787			$	765			$	2,227		$	2,412

Income Tax and Interest Payments

We made federal and foreign income tax payments, net of refunds received, of $702 million and $918 million during the nine-month periods ended September 27, 2009 and September 28, 2008. We have recorded liabilities for unrecognized tax benefits related to permanent and temporary tax adjustments which, exclusive of interest, totaled $216 million and $250 million as of September 27, 2009 and December 31, 2008. The decrease in the liability was primarily due to recognition of tax benefits related to resolution and settlement of issues with the IRS for years 2005-2007. We have protested to the IRS Appeals Division certain proposed adjustments related to tax years 2003-2004 and 2005-2007. We have adequately provided for those proposed adjustments.

Over the next 12 months, it is expected that the IRS examination of our U.S. Federal Income Tax Return for 2008, IRS Appeals review of issues for tax years 2003-2004 and 2005-2007, and certain non-domestic income tax issues will be resolved. It is reasonably possible that resolution of these matters could cause a reduction in our unrecognized tax benefits of up to $186 million, only a portion of which may affect net earnings.

Our total interest payments were $194 million and $226 million during the nine-month periods ended September 27, 2009 and September 28, 2008.

 

Derivative Financial Instruments

In the first quarter of 2009, we adopted a recently issued accounting standard which requires enhanced qualitative disclosures about our objectives and strategies for using derivatives and quantitative disclosures about the fair value amounts of gains and losses on derivative instruments.

We use derivative financial instruments to manage our exposure to fluctuations in foreign currency exchange rates. Foreign currency exchange contracts are entered into to manage the foreign currency exchange rate risk of forecasted foreign currency denominated cash receipts and cash payments. The majority of our foreign currency exchange contracts are designated as cash flow hedges. We may also use derivative financial instruments to manage our exposure to changes in interest rates. Our financial instruments that are subject to interest rate risk principally include fixed rate long-term debt. We do not hold or issue derivative financial instruments for trading or speculative purposes.

We record derivatives at their fair value. The classification of gains and losses resulting from changes in the fair values of derivatives is dependent on our intended use of the derivative and its resulting designation. Adjustments to reflect changes in fair values of derivatives that we consider highly effective hedges are either reflected in earnings and largely offset by corresponding adjustments to the hedged items, or reflected net of income taxes in accumulated other comprehensive income (loss) until the hedged transaction is recognized in earnings, to the extent these derivatives are effective hedges. Changes in the fair value of the derivatives that are attributable to the ineffective portion of the hedges, or of derivatives that are not considered to be highly effective hedges, if any, are immediately recognized in earnings. The aggregate notional amount of the outstanding foreign currency exchange contracts at September 27, 2009 was $1.8 billion. There were no interest rate derivatives outstanding at September 27, 2009.

The effect of our derivative instruments on the Statement of Earnings for the quarter and nine months ended September 27, 2009 was not material. The fair values of our derivative assets and liabilities as of September 27, 2009 were $36 million and $21 million, and were recorded in other current assets and other current liabilities. These amounts were not material to our financial statements. See Note 7 for further discussion on the fair value measurements related to our derivative instruments.

Recent Accounting Pronouncements

In October 2009, the Financial Accounting Standards Board (FASB) revised its accounting guidance related to revenue arrangements with multiple deliverables. The guidance relates to the determination of when the individual deliverables included in a multiple-element arrangement may be treated as separate units of accounting and modifies the manner in which the transaction consideration is allocated across the individual deliverables. Also, the guidance expands the disclosure requirements for revenue arrangements with multiple deliverables. The guidance will be effective for us beginning on January 1, 2011, and may be applied retrospectively for all periods presented or prospectively to arrangements entered into or materially modified after the adoption date. Early adoption is permitted provided that the guidance is retroactively applied to the beginning of the year of adoption. We are currently assessing the potential effect, if any, on our financial statements.

In June 2009, the FASB issued an accounting standard which changes the approach to determining the primary beneficiary of a variable interest entity (“VIE”) and requires companies to continuously assess whether they must consolidate VIEs. This standard is effective for us beginning on January 1, 2010. We are currently assessing the potential effect, if any, on our financial statements.

In May 2008, the FASB issued an accounting standard which affects the accounting for certain convertible debt instruments. The standard was effective beginning with our first quarter 2009 financial reporting, requires retrospective application to all periods presented, and does not grandfather existing debt instruments. The standard would have changed the accounting for our previously outstanding $1.0 billion in original principal amount of floating rate convertible debentures in that it would have required that we bifurcate the proceeds from the debt issuance between a debt and equity component as of the August 2003 issuance date and through the August 2008 date that they were converted or redeemed. The equity component would have reflected the value of the conversion feature of the debentures. We did not adopt the provisions of the standard for the floating rate convertible debentures that were delivered for conversion or redeemed in August 2008, as the effect on our previously reported financial statements was not material.

In December 2007, the FASB issued an accounting standard which would have required that the noncontrolling interests in consolidated subsidiaries be presented as a separate component of stockholders’ equity in the balance sheet, that the amount of consolidated net earnings attributable to the parent and the noncontrolling interest be separately presented in the statement of earnings, and that the amount of consolidated other comprehensive income attributable to the noncontrolling interest be separately disclosed. The standard also would have required gains or losses from the sale of stock of subsidiaries where control is maintained to be recognized as an equity transaction. The standard was effective beginning with our first quarter 2009 financial reporting. We did not adopt the presentation or disclosure provisions of this standard relative to our noncontrolling interests, as the effect on our financial statements was not material.

In the first half of 2009, we adopted accounting standards issued by the FASB related to the following topics, none of which had a material effect on our financial statements:

 

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Accounting and disclosures for subsequent events;

 

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Determining fair value when the volume and level of activity for an asset or liability have significantly decreased and identifying transactions that are not orderly;

 

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Interim disclosures about fair value of financial instruments;

 

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Recognition and presentation of other-than-temporary impairments;

 

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Fair value disclosures related to certain non-financial assets and liabilities;

 

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Determining whether instruments granted in share-based payment transactions are participating securities;

 

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Revised accounting rules related to business combinations; and

 

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Increased disclosures related to derivative financial instruments (see “Derivative Financial Instruments” section above).