Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

OVERVIEW

The following Management’s Discussion and Analysis (“MD&A”) is intended to assist in an understanding of our financial condition and results of operations. This MD&A is provided as a supplement to, should be read in conjunction with, and is qualified in its entirety by reference to, our Consolidated Financial Statements and accompanying Notes appearing elsewhere in this Report. Except for the historical information contained herein, the discussions in this MD&A contain forward-looking statements that involve risks and uncertainties. Our future results could differ materially from those discussed herein. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below in this MD&A under “Forward-Looking Statements and Factors that May Affect Future Results.”

The following is a list of the sections of this MD&A, together with our perspective on their contents, which we hope will assist in reading these pages:


•	Business Considerations — a general description of our business; the value drivers of our business; fiscal 2018 results of operations and liquidity and capital resources key indicators; and industry-wide opportunities, challenges and risks that are relevant to us in defense, government and commercial markets.


•	Operations Review — an analysis of our consolidated results of operations and of the results in each of our business segments, to the extent the segment operating results are helpful to an understanding of our business as a whole, for the three years presented in our financial statements.


•	Liquidity, Capital Resources and Financial Strategies — an analysis of cash flows, funding of pension plans, common stock repurchases, dividends, capital structure and resources, contractual obligations, off-balance sheet arrangements, commercial commitments, financial risk management, impact of foreign exchange and impact of inflation.


•	Critical Accounting Policies and Estimates — a discussion of accounting policies and estimates that require the most judgment and a discussion of accounting pronouncements that have been issued but not yet implemented by us and their potential impact on our financial condition, results of operations and cash flows.


•	Forward-Looking Statements and Factors that May Affect Future Results — cautionary information about forward-looking statements and a description of certain risks and uncertainties that could cause our actual results to differ materially from our historical results or our current expectations or projections.

BUSINESS CONSIDERATIONS

General

We generate revenue, income and cash flows by developing, manufacturing or providing, and selling advanced, technology-based solutions that solve government and commercial customers’ mission-critical challenges. We support government and commercial customers in more than 100 countries, with our largest customers being various departments and agencies of the U.S. Government and their prime contractors. Our products, systems and services have defense and civil government applications, as well as commercial applications. As of the end of fiscal 2018, we had approximately 17,500 employees, including approximately 7,900 engineers and scientists. We generally sell directly to our customers, and we utilize agents and intermediaries to sell and market some products and services, especially in international markets.

We structure our operations primarily around the products, systems and services we sell and the markets we serve, and we report the financial results of our continuing operations in the following three reportable segments, which are also referred to as our business segments:


•	Communication Systems, serving markets in tactical communications and defense products, including tactical ground and airborne radio communications solutions and night vision technology, and in public safety networks;


•	Electronic Systems, providing electronic warfare, avionics, and C4ISR solutions for defense and classified customers and mission-critical communication systems for civil and military aviation and other customers; and


•	Space and Intelligence Systems, providing intelligence, space protection, geospatial, complete Earth observation, universe exploration, PNT, and environmental solutions for national security, defense, civil and commercial customers, using advanced sensors, antennas and payloads, as well as ground processing and information analytics.

As described above and in more detail in Note 1: Significant Accounting Policies under “Principles of Consolidation” and in Note 3: Discontinued Operations and Divestitures in the Notes, we completed the divestiture of CapRock in the third quarter of fiscal 2017 and the divestiture of IT Services in the fourth quarter of fiscal 2017. CapRock and IT Services were part of our former Critical Networks segment and are reported as discontinued operations in this Report. Our historical financial results

have been restated for all periods presented in this Report to account for businesses reported as discontinued operations in this Report. Except for disclosures related to our cash flows, or unless otherwise specified, disclosures in this Report relate solely to our continuing operations.

In connection with entering into the definitive agreement to sell IT Services, our other remaining operations that had been part of our former Critical Networks segment, including our ATM business and our PMRF program, were integrated with our Electronic Systems segment effective for the third quarter of fiscal 2017, and our Critical Networks segment was eliminated. The historical results, discussion and presentation of our business segments as set forth in this Report reflect the impact of these changes for all periods presented in order to present all segment information on a comparable basis. There is no impact on our previously reported consolidated statements of income, balance sheets or statements of cash flows resulting from these segment changes.

Value Drivers of Our Business

In recent years, we have reshaped our portfolio of businesses to focus on high-growth, high-margin businesses, successfully integrated Exelis and made investments that led to several new product launches and strategic program awards. Fiscal 2018 marked an inflection point as we returned to growth across all three business segments, maintained strong margins through our focus on operational excellence and recorded significantly higher orders that drove a 26 percent increase in backlog for fiscal 2018 compared with fiscal 2017. In addition to dividends and share repurchases, we made debt repayments and voluntary pension plan contributions that expanded our future financial flexibility. We plan to build on our strong fiscal 2018 performance, and together with a well-funded U.S. Government budget and a continued focus on operational excellence and innovation, we believe we are well positioned to achieve our fiscal 2019 strategic priorities, which include the following:


•	Accelerating revenue growth across all three business segments;


•	Driving flawless execution while expanding margins through operational excellence; and


•	Sustaining cash flow with shareholder friendly capital deployment.

We expect a more favorable budget environment, especially in strategic areas, our solid fiscal 2018 backlog growth and strong customer relationships to serve as the basis for accelerating revenue growth across our business segments in fiscal 2019. The Government Fiscal Year (“GFY”) 2018 Omnibus Appropriations Bill reflected that our programs continue to remain a priority for U.S. Government customers, and President Trump’s GFY 2019 budget proposal would fully fund all of our major DoD and civil agency programs. For Communication Systems, DoD tactical modernization programs are beginning to increase across all the services, and we expect our international tactical business to be able to leverage its incumbent position and large installed base and benefit from higher defense spending by coalition partners. In Electronic Systems, we believe we are entering a multi-year growth cycle driven by our position on long-term avionics and electronic warfare platforms. For Space and Intelligence Systems, we believe, in a growing budget environment, we will be able to maintain high win-rates and expand into adjacencies in order to accelerate growth in classified programs, and we expect our environmental business to stabilize and return to growth.

We believe operational leverage from accelerating growth across our business segments, combined with our continued focus on operational excellence and innovation, will drive margin expansion and increased profitability.

Our operational excellence program, Harris Business Excellence (“HBX”), is focused on streamlining processes, eliminating waste, reducing costs, optimizing program execution and increasing customer satisfaction. We are approximately half-way through standardizing our IT systems, which we expect will dramatically reduce the number of enterprise resource planning platforms, simplify our operating environment, drive productivity through growth in shared services, automate core processes and lay the foundation of our enterprise-wide digital strategy. We are working toward eliminating many of our data centers and making the remainder cloud-enabled. We also are continuing to focus on cost savings in our supply chain through “value engineering” and “should-cost” analysis, as well as improving supplier performance and reducing sole-sourced components on legacy solutions.

Innovation is at the core of our success, and R&D investment represents the foundation for innovation. We are fundamentally reshaping how we design and develop new products to get more out of our R&D investment. We are deploying “DevOps” to streamline software development, which has grown to be a significant portion of our engineering work today and is expected to increase over time. We also use standardized processes and common metrics to track progress and gauge success, as well as core technology centers to more fully leverage R&D investment across our Company.

During fiscal 2018, we returned to our shareholders $272 million in dividends and another $272 million through share repurchases. We also used $271 million for net repayment of borrowings and $300 million for a voluntary contribution to our U.S. defined benefit plans, which helped reduce our net unfunded defined benefit plans liability by 44 percent to $0.7 billion or 11 percent of total liabilities at the end of fiscal 2018. In fiscal 2019, we believe accelerating revenue growth across our business segments, margin expansion and increased profitability will improve our operating cash flow, which we expect to use for increased dividends, share repurchases, debt repayments and reinvestment to grow our strategic businesses.

Key Indicators

We believe our value drivers, when implemented, will improve our financial results, including: revenue; income from continuing operations; income from continuing operations as a percentage of revenue; income from continuing operations per diluted common share; net cash provided by operating activities; return on invested capital; return on average equity; and consolidated total indebtedness to total capital ratio. The measure of our success is reflected in our results of operations and liquidity and capital resources key indicators as discussed below.

Fiscal 2018 Results of Operations Key Indicators: Revenue, income from continuing operations, income from continuing operations per diluted common share and income from continuing operations as a percentage of revenue represent key measurements of our value drivers:


•	Revenue increased 5 percent to $6.2 billion in fiscal 2018 from $5.9 billion in fiscal 2017;


•	Income from continuing operations increased 13 percent to $721 million in fiscal 2018 from $638 million in fiscal 2017;


•	Income from continuing operations as a percentage of revenue increased to 12 percent in fiscal 2018 from 11 percent in fiscal 2017; and


•	Income from continuing operations per diluted common share increased 16 percent to $5.94 in fiscal 2018 from $5.12 in fiscal 2017, reflecting both the increase in income from continuing operations as noted above and fewer diluted common shares outstanding due to repurchases of shares of common stock under our repurchase program during fiscal 2018.

Refer to MD&A heading “Operations Review” below in this Report for more information.

Liquidity and Capital Resources Key Indicators: Net cash provided by operating activities, return on invested capital, return on average equity, our consolidated total indebtedness to total capital ratio and our net unfunded defined benefit plans liability also represent key measurements of our value drivers:


•	Net cash provided by operating activities increased to $751 million in fiscal 2018 from $569 million in fiscal 2017;


•	Return on invested capital (defined as after-tax operating income from continuing operations divided by the two-point average of invested capital at the beginning and end of the fiscal year, where invested capital equals equity plus debt, less cash and cash equivalents) increased to 13 percent in fiscal 2018 from 11 percent in fiscal 2017;


•	Return on average equity (defined as income from continuing operations divided by the two-point average of equity at the beginning and end of the fiscal year) increased to 23 percent in fiscal 2018 from 21 percent in fiscal 2017;


•	Our consolidated total indebtedness to total capital ratio at June 29, 2018 was 53 percent, compared with our 65 percent covenant limitation under our senior unsecured revolving credit facility; and


•	Our net unfunded defined benefit plans liability decreased $0.6 billion in fiscal 2018 to $0.7 billion at June 29, 2018 compared with $1.3 billion at June 30, 2017.

Refer to MD&A heading “Liquidity, Capital Resources and Financial Strategies” below in this Report for more information on net cash provided by (used in) operating, investing and financing activities.

Industry-Wide Opportunities, Challenges and Risks

Department of Defense and Other U.S. Federal Markets: Our largest customers are various departments and agencies of the U.S. Government — the percentage of our revenue that was derived from sales to U.S. Government customers, including foreign military sales funded through the U.S. Government, whether directly or through prime contractors, in fiscal 2018, 2017 and 2016 was approximately 75 percent, 74 percent and 77 percent, respectively. The GFY 2018 (U.S. Government fiscal years begin October 1 and end September 30) budget cycle ended with the Omnibus Appropriations Bill being passed by Congress and signed by President Trump on March 23, 2018. Our programs were fully funded and continue to remain priorities for U.S. Government customers.

In February 2018, President Trump submitted a budget proposal for GFY 2019 to Congress that would fully fund all of our major DoD and civil agency programs. The GFY 2019 budget proposal includes $617 billion in DoD base funding and an additional $69 billion in Overseas Contingency Operations (“OCO”) funding. The DoD budget proposal would increase funding across all of the services, including SOCOM, compared with GFY 2018 Omnibus Appropriations Bill levels.

In February 2018, President Trump signed into law the Bipartisan Budget Act of 2018 (“BBA 2018”), which increased the sequester caps on discretionary defense spending imposed by the Budget Control Act of 2011 (“BCA”) by $80 billion in GFY 2018 and $85 billion in GFY 2019, providing more certainty in the near-term budget planning process. The BCA had previously established limits on discretionary spending and reduced planned defense spending by $487 billion over a ten-year period beginning with GFY 2012. The BCA also provided additional automatic spending reductions, known as sequestration, that would have resulted in an additional $500 billion reduction to planned defense spending over a nine-year period

beginning with GFY 2013. The BBA 2018 did not impact GFYs 2020 through 2022 — the budget caps and the across-the-board spending reduction methodology provided under the BCA remain intact.

On August 12, 2018, President Trump signed the 2019 National Defense Authorization Act, and although we anticipate debate will continue within the U.S. Government over defense spending for GFY 2019 (which may have a significant impact on defense spending broadly and on our specific programs), our programs have been well supported in the GFY 2018 Omnibus Appropriations Bill and the President’s GFY 2019 budget proposal.

Government Oversight and Risk: As a U.S. Government contractor, we are subject to U.S. Government oversight. The U.S. Government may investigate our business practices and audit our compliance with applicable rules and regulations. Depending on the results of those investigations and audits, the U.S. Government could make claims against us. Under U.S. Government procurement regulations and practices, an indictment or conviction of a government contractor could result in that contractor being fined and/or suspended from being able to bid on, or from being awarded, new U.S. Government contracts for a period of time determined by the U.S. Government. Similar government oversight exists in most other countries where we conduct business.

For a discussion of risks relating to U.S. Government contracts and subcontracts, see “Item 1. Business — Principal Customers; Government Contracts” and “Item 1A. Risk Factors” of this Report. We are also subject to other risks associated with U.S. Government business, including technological uncertainties, dependence on annual appropriations and allotment of funds, extensive regulations and other risks, which are discussed in “Item 1A. Risk Factors” and “Item 3. Legal Proceedings” of this Report.

State and Local: We also provide products to state and local government agencies that are committed to protecting our homeland and public safety. The public safety market was in fiscal 2018, and is expected to continue to be in fiscal 2019, highly competitive and dependent on state and local government budgets. Future market opportunities include upgrading aging analog infrastructure to new digital standards, as well as opportunities associated with next-generation LTE solutions for high data-rate applications.

International: We believe there is continuing international demand from military and government customers for tactical radios, public safety communications, electronic warfare equipment, air traffic management, electronic attack and release systems and ISR. We believe we can leverage our domain expertise and proven technology provided in the U.S. to further expand our international business.

We believe that our experience, technologies and capabilities are well aligned with the demand and requirements of the markets noted above in this Report. However, we remain subject to the spending levels, pace and priorities of the U.S. Government as well as international governments and commercial customers, and to general economic conditions that could adversely affect us, our customers and our suppliers. We also remain subject to other risks associated with these markets, including technological uncertainties, adoption of our new products and other risks that are discussed below in this Report under “Forward-Looking Statements and Factors that May Affect Future Results” and in “Item 1A. Risk Factors” of this Report.

OPERATIONS REVIEW

Consolidated Results of Operations



	Fiscal Years Ended
	2018			2017			2018/2017 Percent Increase/ (Decrease)		2016			2017/2016 Percent Increase/ (Decrease)

	(Dollars in millions, except per share amounts)
Revenue:
Communication Systems	$	1,903		$	1,753		9	%	$	1,864		(6	)%
Electronic Systems	2,373			2,251			5	%	2,233			1	%
Space and Intelligence Systems	1,921			1,902			1	%	1,899			—
Corporate eliminations	(15		)	(6		)	*		(4		)	*
Total revenue	6,182			5,900			5	%	5,992			(2	)%
Cost of product sales and services:
Cost of product sales	(3,106		)	(2,964		)	5	%	(3,079		)	(4	)%
% of revenue from product sales	61		%	64		%			64		%
Cost of services	(825		)	(770		)	7	%	(753		)	2	%
% of revenue from services	74		%	62		%			64		%
Total cost of product sales and services	(3,931		)	(3,734		)	5	%	(3,832		)	(3	)%
% of total revenue	64		%	63		%			64		%
Gross margin	2,251			2,166			4	%	2,160			—
% of total revenue	36		%	37		%			36		%
Engineering, selling and administrative expenses	(1,129		)	(1,093		)	3	%	(1,105		)	(1	)%
% of total revenue	18		%	19		%			18		%
Operating income	1,122			1,073			5	%	1,055			2	%
% of total revenue	18		%	18		%			18		%
Non-operating income (loss)	(28		)	2			*		10			*
Net interest expense	(168		)	(170		)	(1	)%	(181		)	(6	)%
Income from continuing operations before income taxes	926			905			2	%	884			2	%
Income taxes	(205		)	(267		)	(23	)%	(273		)	(2	)%
Effective tax rate	22		%	30		%			31		%
Income from continuing operations	$	721		$	638		13	%	$	611		4	%
% of total revenue	12		%	11		%			10		%
Income from continuing operations per diluted common share	$	5.94		$	5.12		16	%	$	4.87		5	%

Not meaningful

Revenue

Fiscal 2018 Compared With Fiscal 2017: The increase in revenue in fiscal 2018 compared with fiscal 2017 was primarily due to higher DoD tactical radio sales in our Communication Systems segment, reflecting readiness and modernization demand from the U.S. Army and U.S. Air Force, and higher Avionics and Electronic Warfare revenue from long-term avionics platforms, including the F-35, F/A-18 and F-16, and higher revenue from C4ISR (including wireless solutions) in our Electronic Systems segment.

Fiscal 2017 Compared With Fiscal 2016: The decrease in revenue in fiscal 2017 compared with fiscal 2016 was primarily due to lower Tactical Communications revenue in our Communication Systems segment and lower revenue due to the impact of the divestiture of our Aerostructures business in the fourth quarter of fiscal 2016, which contributed $60 million of revenue in fiscal 2016 in our Electronic Systems segment, and the impact of certain environmental and commercial space programs in our Space and Intelligence Systems segment transitioning from a build-out to a sustainment phase, partially offset by higher revenue from the ramp up of the United Arab Emirates BMS-ELTS integrated battle management system program and from Electronic Warfare in our Electronic Systems segment and by $36 million of higher revenue from classified customers in our Space and Intelligence Systems segment.

See the “Discussion of Business Segment Results of Operations” discussion below in this MD&A for further information.

Gross Margin

Fiscal 2018 Compared With Fiscal 2017: Gross margin increased in fiscal 2018 compared with fiscal 2017 primarily due to higher revenue, partially offset by a 1 percentage point decrease in gross margin as a percentage of revenue (“gross margin percentage”). The decrease in gross margin percentage in fiscal 2018 compared with fiscal 2017 reflected a less favorable mix of program revenue and product sales and an unfavorable impact from the ADS-B program, including a favorable contract settlement in the second quarter of fiscal 2017 and the program transition from build-out to sustainment, partially offset by productivity savings and incremental pension income.

Fiscal 2017 Compared With Fiscal 2016: Gross margin increased in fiscal 2017 compared with fiscal 2016 primarily due to a 1 percentage point increase in gross margin percentage reflecting cost containment, integration-related synergy savings and higher pension income, partially offset by lower margins from the ADS-B program as it transitioned from build-out to sustainment in the third and fourth quarters of fiscal 2017 and the margin impact of lower revenue in our Communication Systems segment.

See the “Discussion of Business Segment Results of Operations” discussion below in this MD&A for further information.

Engineering, Selling and Administrative Expenses

Fiscal 2018 Compared With Fiscal 2017: The increase in engineering, selling and administrative (“ESA”) expenses in fiscal 2018 compared with fiscal 2017 was primarily due to $47 million of charges related to our decision to transition and exit a commercial air-to-ground LTE radio communications line of business and other items, higher employment and distribution costs and a $12 million non-cash adjustment for deferred compensation, partially offset by a $53 million reduction in Exelis acquisition-related and other charges in fiscal 2018 compared with fiscal 2017. The decrease in ESA expenses as a percentage of revenue (“ESA percentage”) in fiscal 2018 compared with fiscal 2017 was primarily due to cost containment.

Overall Company-sponsored R&D costs were $311 million in fiscal 2018 compared with $310 million in fiscal 2017.

Fiscal 2017 Compared With Fiscal 2016: The decrease in ESA expenses in fiscal 2017 compared with fiscal 2016 was primarily due to cost containment, integration-related synergy savings and a $63 million reduction in integration and other costs associated with our acquisition of Exelis in the fourth quarter of 2015, partially offset by the benefit in fiscal 2016 of $101 million net liability reduction for certain post-employment benefit plans recorded during the second quarter of fiscal 2016. ESA percentage in fiscal 2017 was comparable with fiscal 2016.

Overall Company-sponsored R&D costs were $310 million in fiscal 2017 compared with $305 million in fiscal 2016.

See the “Discussion of Business Segment Results of Operations” discussion below in this MD&A for further information.

Operating Income

Fiscal 2018 Compared With Fiscal 2017: The increase in operating income and comparability of operating income as a percentage of total revenue (“operating margin percentage”) in fiscal 2018 compared with fiscal 2017 were primarily due to the combined effects of the reasons noted above in this “Consolidated Results of Operations” discussion regarding fiscal 2018 and 2017.

Fiscal 2017 Compared With Fiscal 2016: The increase in operating income and comparability of operating margin percentage in fiscal 2017 compared with fiscal 2016 were primarily due to the combined effects of the reasons noted above in this “Consolidated Results of Operations” discussion regarding fiscal 2017 and 2016.

Non-Operating Income (Loss)

Fiscal 2018 Compared With Fiscal 2017: Non-operating loss in fiscal 2018 was primarily due to $27 million of losses and other costs related to debt refinancing in the fourth quarter of fiscal 2018. Non-operating income in fiscal 2017 was primarily due to an adjustment to the net gain on the sale of Aerostructures.

Fiscal 2017 Compared With Fiscal 2016: Non-operating income in fiscal 2017 was primarily due to the same reason as noted above for fiscal 2017 non-operating income. Non-operating income in fiscal 2016 was primarily due to a $10 million net gain on the divestiture of Aerostructures during the fourth quarter of fiscal 2016.

See Note 19: Non-Operating Income (Loss) in the Notes for further information.

Net Interest Expense

Fiscal 2018 Compared With Fiscal 2017: Our net interest expense decreased in fiscal 2018 compared with fiscal 2017 primarily due to lower average debt levels as a result of $271 million of net repayment of borrowings, which included our repayment at maturity of the entire outstanding $500 million aggregate principal amount of our 1.999% Notes due April 27, 2018. See Note 12: Debt in the Notes for further information.

Fiscal 2017 Compared With Fiscal 2016: Our net interest expense decreased in fiscal 2017 compared with fiscal 2016 primarily due to lower average debt levels as a result of $499 million of net repayment of borrowings, which included $313

million of repayment of our variable-rate term loans and our repayment of the entire outstanding $250 million aggregate principal amount of our 4.25% notes due October 1, 2016.

Income Taxes

Fiscal 2018 Compared With Fiscal 2017: In fiscal 2018, our effective tax rate (income taxes as a percentage of income from continuing operations before income taxes) benefited from the net favorable impact of:


•	The enactment of a lower U.S. statutory corporate income tax rate in fiscal 2018;


•	Additional research credits claimed on our fiscal 2017 tax return compared with our recorded estimates at the end of fiscal 2017; and


•	The favorable impact of releasing provisions for uncertain tax positions.

In fiscal 2017, our effective tax rate benefited from:


•	The favorable impact of excess tax benefits related to equity-based compensation;


•	Several differences between U.S. generally accepted accounting principles (“GAAP”) and tax accounting related to investments; and


•	Additional deductions and additional research credits claimed on our fiscal 2016 tax return compared with our recorded estimates at the end of fiscal 2016.

Fiscal 2017 Compared With Fiscal 2016: The major discrete items from which our fiscal 2017 effective tax rate benefited are those noted for fiscal 2017 in the preceding discussion under “Income Taxes.” In fiscal 2016, our effective tax rate benefited from:


•	Settlement of several items for amounts that were lower than previously recorded estimates;


•	Legislation enacted in the second quarter of fiscal 2016 that restored the U.S. Federal income tax credit for qualifying R&D expenses for calendar year 2015 and made the credit permanent for the periods following December 31, 2015;


•	Recognition of a tax loss, net of valuation allowances, upon the divestiture of Aerostructures;


•	State tax reductions resulting from our integration of Exelis operations; and


•	Several differences between GAAP and tax accounting related to investments.

See Note 21: Income Taxes in the Notes for further information.

Income From Continuing Operations

Fiscal 2018 Compared With Fiscal 2017: The increase in income from continuing operations in fiscal 2018 compared with 2017 was primarily due to the combined effects of the reasons noted above in this “Consolidated Results of Operations” discussion regarding fiscal 2018 and 2017.

Fiscal 2017 Compared With Fiscal 2016: The increase in income from continuing operations in fiscal 2017 compared with 2016 was primarily due to the combined effects of the reasons noted above in this “Consolidated Results of Operations” discussion regarding fiscal 2017 and 2016.

Income From Continuing Operations Per Diluted Common Share

Fiscal 2018 Compared With Fiscal 2017: The increase in income from continuing operations per diluted common share in fiscal 2018 compared with fiscal 2017 was due to the increase in income from continuing operations in fiscal 2018 compared with fiscal 2017 and the net impact of shares of our common stock repurchased under our repurchase program during fiscal 2018, shares issued under our stock incentive and defined contribution plans and the incremental dilutive impact of share-based awards during fiscal 2018 compared with fiscal 2017.

Fiscal 2017 Compared With Fiscal 2016: The increase in income from continuing operations per diluted common share in fiscal 2017 compared with fiscal 2016 was due to the increase in income from continuing operations in fiscal 2017 compared with fiscal 2016 and fewer diluted weighted average common shares outstanding due to significant levels of repurchases of shares of common stock under our repurchase program during fiscal 2017.

See the “Common Stock Repurchases” discussion and the “Common Stock” paragraph of the “Capital Structure and Resources” discussion below in this MD&A for further information.

Discontinued Operations, Net of Income Taxes

See Note 3: Discontinued Operations and Divestitures in the Notes for information regarding IT Services and CapRock, which are reported as discontinued operations in this Report. As a result, our historical financial results have been restated to account for IT Services and CapRock as discontinued operations for all periods presented in this Report.

Discussion of Business Segment Results of Operations

Communication Systems Segment



	2018			2017			2018/2017 Percent Increase/ (Decrease)		2016			2017/2016 Percent Increase/ (Decrease)

	(Dollars in millions)
Revenue	$	1,903		$	1,753		9	%	$	1,864		(6	)%
Cost of product sales and services	(992		)	(894		)	11	%	(941		)	(5	)%
Gross margin	911			859			6	%	923			(7	)%
% of revenue	48		%	49		%			50		%
ESA expenses	(340		)	(335		)	1	%	(401		)	(16	)%
% of revenue	18		%	19		%			22		%
Segment operating income	$	571		$	524		9	%	$	522		—
% of revenue	30		%	30		%			28		%

Fiscal 2018 Compared With Fiscal 2017: The increase in segment revenue in fiscal 2018 compared with fiscal 2017 was primarily due to $138 million higher DoD tactical radio sales, reflecting readiness and modernization demand from the U.S. Army and U.S. Air Force, and higher Night Vision revenue primarily due to demand from the U.S. Army.

The increase in segment gross margin in fiscal 2018 compared with fiscal 2017 was primarily attributable to the increase in revenue. Segment gross margin percentage decreased 1 percentage point in fiscal 2018 compared with fiscal 2017 due to the impact of a less favorable mix of program revenue and product sales, mostly offset by productivity savings. The increase in segment ESA expenses in fiscal 2018 compared with fiscal 2017 was primarily due to higher employment costs, partially offset by cost containment. The decrease in segment ESA percentage in fiscal 2018 compared with fiscal 2017 was primarily due to cost containment. The increase in segment operating income and comparability in segment operating margin percentage in fiscal 2018 compared with fiscal 2017 reflected the combined effects of the items discussed above regarding this segment.

The percentage of this segment’s revenue that was derived from sales to U.S. Government customers, including foreign military sales funded through the U.S. Government, whether directly or through prime contractors, was approximately 48 percent in fiscal 2018 and 42 percent in fiscal 2017.

Fiscal 2017 Compared With Fiscal 2016: The decrease in segment revenue in fiscal 2017 compared to fiscal 2016 was primarily due to $85 million lower revenue from legacy Exelis tactical radios and night vision products and the wind-down of a significant international network project in Public Safety and Professional Communications.

The decrease in segment gross margin in fiscal 2017 compared with fiscal 2016 was primarily attributable to the decrease in revenue, partially offset by lower restructuring charges. Segment gross margin percentage decreased 1 percentage point in fiscal 2017 compared with fiscal 2016, despite 6 percent lower revenue and a less favorable revenue mix, primarily due to cost containment and Exelis acquisition integration-related synergy savings. The decreases in segment ESA expenses and ESA percentage in fiscal 2017 compared with fiscal 2016 were primarily due to cost containment, lower restructuring costs and Exelis acquisition integration-related synergy savings. The slight increase in segment operating income and the increase in segment operating margin percentage in fiscal 2017 compared with fiscal 2016 reflected the combined effects of the items discussed above regarding this segment for fiscal 2017 and 2016. Segment operating margin percentage increased 2 percentage points in fiscal 2017 compared with fiscal 2016 despite the impact of 6 percent lower revenue over the same period.

The percentage of this segment’s revenue that was derived from sales to U.S. Government customers, including foreign military sales funded through the U.S. Government, whether directly or through prime contractors, was approximately 42 percent in fiscal 2017 and 52 percent in fiscal 2016.

Electronic Systems Segment



	2018			2017			2018/2017 Percent Increase/ (Decrease)		2016			2017/2016 Percent Increase/ (Decrease)

	(Dollars in millions)
Revenue	$	2,373		$	2,251		5	%	$	2,233		1	%
Cost of product sales and services	(1,651		)	(1,529		)	8	%	(1,539		)	(1	)%
Gross margin	722			722			—		694			4	%
% of revenue	30		%	32		%			31		%
ESA expenses	(281		)	(258		)	9	%	(264		)	(2	)%
% of revenue	12		%	11		%			12		%
Segment operating income	$	441		$	464		(5	)%	$	430		8	%
% of revenue	19		%	21		%			19		%

Fiscal 2018 Compared With Fiscal 2017: The increase in segment revenue in fiscal 2018 compared with fiscal 2017 was primarily due to $75 million of higher Avionics and Electronic Warfare revenue from long-term platforms, including the F-35, F/A-18 and F-16, and $46 million higher revenue from C4ISR (including wireless solutions), reflecting the ramp up of the U.K. Robotics and BMS-ELTS programs, partially offset by lower revenue from Mission Networks.

The comparability of segment gross margin and the decrease in segment gross margin percentage in fiscal 2018 compared with fiscal 2017 were primarily due to a $36 million unfavorable impact from the ADS-B program, including a favorable contract settlement in the second quarter of fiscal 2017 and the program transition from build-out to sustainment, and a less favorable mix of program revenue, partially offset by productivity savings. The increases in segment ESA expenses and ESA percentage in fiscal 2018 compared with fiscal 2017 were primarily due to increased R&D investments, higher employment costs and timing of other expense accruals.

The decreases in segment operating income and operating margin percentage in fiscal 2018 compared fiscal 2017 reflected the combined effects of the items discussed above regarding this segment.

Fiscal 2017 Compared With Fiscal 2016: The increase in segment revenue in fiscal 2017 compared with fiscal 2016 was primarily due to higher revenue from the ramp up of the BMS-ELTS program and from electronic warfare solutions, partially offset by $60 million of lower revenue attributable to the divestiture of Aerostructures in the fourth quarter of fiscal 2016 and $41 million of lower revenue from the impact of the ADS-B program transition from a build-out to a sustainment phase.

The increases in segment gross margin and gross margin percentage in fiscal 2017 compared with fiscal 2016 were primarily due to continued strong program performance principally from Electronic Warfare and higher pension income, partially offset by a $21 million unfavorable margin impact from the ADS-B program transitioning from a build-out to a sustainment phase. The decreases in segment ESA expenses and ESA percentage in fiscal 2017 compared with fiscal 2016 was primarily due to Exelis acquisition integration-related synergy savings and $8 million of charges for restructuring and other costs recorded in fiscal 2016, partially offset by $13 million of higher R&D expenses. The increases in segment operating income and operating margin percentage in fiscal 2017 compared with fiscal 2016 reflected the combined effects of the items discussed above regarding this segment for fiscal 2017 and 2016. Segment operating margin percentage increased 2 percentage points in fiscal 2017 compared with fiscal 2016 despite revenue increasing only 1 percent over the same period.

The percentage of this segment’s revenue that was derived from sales to U.S. Government customers, including foreign military sales funded through the U.S. Government, whether directly or through prime contractors, was approximately 82 percent in fiscal 2017 and 83 percent in fiscal 2016.

Space and Intelligence Systems Segment



	2018			2017			2018/2017 Percent Increase/ (Decrease)		2016			2017/2016 Percent Increase/ (Decrease)

	(Dollars in millions)
Revenue	$	1,921		$	1,902		1	%	$	1,899		—
Cost of product sales and services	(1,303		)	(1,317		)	(1	)%	(1,355		)	(3	)%
Gross margin	618			585			6	%	544			8	%
% of revenue	32		%	31		%			29		%
ESA expenses	(282		)	(274		)	3	%	(256		)	7	%
% of revenue	15		%	14		%			13		%
Segment operating income	$	336		$	311		8	%	$	288		8	%
% of revenue	17		%	16		%			15		%

Fiscal 2018 Compared With Fiscal 2017: The increase in segment revenue in fiscal 2018 compared with fiscal 2017 was primarily due to higher revenue from classified programs, primarily driven by space superiority programs, and $14 million higher revenue from commercial customers, offset by $30 million of lower civil revenue reflecting the impact of lower revenue from environmental programs.

The increases in segment gross margin and gross margin percentage in fiscal 2018 compared with fiscal 2017 were primarily due to a more favorable mix of program revenue and incremental pension income. The increases in segment ESA expenses and ESA percentage in fiscal 2018 compared with fiscal 2017 were primarily due to higher employment costs and the timing of other expense accruals.

The increases in segment operating income and operating margin percentage in fiscal 2018 compared with fiscal 2017 reflected the combined effects of the items discussed above regarding this segment.

The percentage of this segment’s revenue that was derived from sales to U.S. Government customers, including foreign military sales funded through the U.S. Government, whether directly or through prime contractors, was approximately 93 percent in fiscal 2018 and 95 percent in fiscal 2017.

Fiscal 2017 Compared With Fiscal 2016: Segment revenue in fiscal 2017 increased slightly compared with fiscal 2016, primarily due to $36 million of higher revenue from classified customers, mostly offset by lower revenue from the impact of certain environmental and commercial space programs transitioning from a build-out to a sustainment phase.

The increases in segment gross margin and gross margin percentage in fiscal 2017 compared with fiscal 2016 were primarily attributable to improved program performance and higher pension income, partially offset by a $30 million impact due to lower revenue from relatively higher-margin environmental and commercial space programs. The increases in segment ESA expenses and ESA percentage in fiscal 2017 compared with fiscal 2016 were primarily due to higher R&D and proposal expenses. The increases in segment operating income and operating margin percentage in fiscal 2017 compared with fiscal 2016 reflected the combined effects of the items discussed above regarding this segment for fiscal 2017 and 2016. Segment operating margin percentage increased 1 percentage point in fiscal 2017 compared with fiscal 2016 despite slight revenue growth over the same period.

Unallocated Corporate Expense and Corporate Eliminations



	2018		2017		2018/2017 Percent Increase/ (Decrease)		2016		2017/2016 Percent Increase/ (Decrease)

	(Dollars in millions)
Unallocated corporate expense and corporate eliminations	$	125	$	117	7	%	$	76	54	%
Amortization of intangible assets from Exelis Inc. acquisition	101		109		(7	%)	109		—	%

Unallocated corporate expense and corporate eliminations represents the portion of corporate expenses not allocated to our business segments and elimination of intersegment profits. Because the Exelis acquisition benefited our entire Company as opposed to any individual segment, we recorded the acquired intangible assets as Corporate assets and the related amortization expense as unallocated corporate expense. Unallocated corporate expense is reported as part of the “Engineering, selling and administrative expenses” line item in our Consolidated Financial Statements.

Fiscal 2018 Compared With Fiscal 2017: The increase in unallocated corporate expense in fiscal 2018 compared with fiscal 2017 was primarily due to $47 million of charges related to our decision to transition and exit a commercial air-to-ground LTE radio communications line of business and other items, a $12 million non-cash adjustment for deferred compensation and the timing of other expense accruals, partially offset by a $53 million reduction in Exelis acquisition-related and other charges in fiscal 2018 compared with fiscal 2017.

Fiscal 2017 Compared With Fiscal 2016: The increase in unallocated corporate expense in fiscal 2017 compared with fiscal 2016 was primarily due to a net liability reduction of $101 million for certain post-employment benefit plans in the second quarter of fiscal 2016, partially offset by a $63 million decrease in Exelis acquisition-related and other charges.

LIQUIDITY, CAPITAL RESOURCES AND FINANCIAL STRATEGIES

Cash Flows



	Fiscal Years Ended
	2018			2017			2016

	(Dollars in millions)
Net cash provided by operating activities	$	751		$	569		$	924
Net cash provided by (used in) investing activities	(141		)	870			(1		)
Net cash used in financing activities	(805		)	(1,438		)	(893		)
Effect of exchange rate changes on cash and cash equivalents	(1		)	(4		)	(24		)

Net increase (decrease) in cash and cash equivalents	(196		)	(3		)	6
Cash and cash equivalents, beginning of year	484			487			481

Cash and cash equivalents, end of year	$	288		$	484		$	487

Cash and cash equivalents

The $196 million net decrease in cash and cash equivalents from the end of fiscal 2017 to the end of fiscal 2018 was primarily due to:


•	$751 million of net cash provided by operating activities, reflecting the impact of a $300 million voluntary pension contribution; and


•	$34 million of proceeds from exercises of employee stock options; more than offset by


•	$272 million used to pay cash dividends;


•	$272 million used to repurchase shares of our common stock;


•	$271 million used for net repayments of borrowings, including:


◦	$850 million in proceeds from the issuance of our 4.40% Notes due June 15, 2028,


◦	$300 million in proceeds from the issuance of our Floating Rate Notes due February 27, 2019,


◦	$250 million in proceeds from the issuance of our Floating Rate Notes due April 30, 2020,


◦	$500 million used for repayment at maturity of the entire outstanding aggregate principal amount of our 1.999% Notes due April 27, 2018,


◦	$415 million used for the optional redemption of our 4.40% Notes due December 15, 2020,


◦	$429 million used for the optional redemption of our 5.55% Notes due October 1, 2021,


◦	$269 million used for repayment of our remaining outstanding indebtedness under the 5-year tranche of our variable-rate term loans due May 29, 2020, and


◦	$36 million used for repayment of our remaining outstanding indebtedness under the 3-year tranche of our variable-rate term loans due May 29, 2018;


•	$136 million used for net additions of property, plant and equipment; and


•	$24 million used in other financing activities.

The $3 million net decrease in cash and cash equivalents from the end of fiscal 2016 to the end of fiscal 2017 was primarily due to:


•	$1,014 million of net proceeds from sales of businesses;


•	$569 million of net cash provided by operating activities, reflecting the impact of a $400 million voluntary pension contribution;


•	$85 million of net proceeds from borrowings;


•	$54 million of proceeds from exercises of employee stock options; more than offset by


•	$710 million used to repurchase shares of our common stock;


•	$584 million of net repayment of borrowings, including:


◦	$313 million used for repayment of our variable-rate term loans, and


◦	$250 million used for repayment at maturity of the entire outstanding aggregate principal amount of our 4.25% notes due October 1, 2016;


•	$262 million used to pay cash dividends;


•	$119 million used for net additions of property, plant and equipment;


•	$25 million for net adjustments to proceeds from the sale of a business; and


•	$21 million used in other financing activities.

We ended fiscal 2018 with cash and cash equivalents of $288 million, and we have a senior unsecured $1 billion revolving credit facility that expires in June 2023 ($925 million of which was available to us as of June 29, 2018 as a result of $75 million of short-term debt outstanding under our commercial paper program). Additionally, we had $3.4 billion of long-term debt outstanding at June 29, 2018, the majority of which we incurred in connection with our acquisition of Exelis in the fourth quarter of fiscal 2015. For further information regarding our long-term debt, see Note 12: Debt in the Notes. Our $288 million of cash and cash equivalents at June 29, 2018 included $134 million held by our foreign subsidiaries, of which $69 million is considered permanently reinvested. Determining the future tax cost of repatriating such funds to the U.S. is not practical at this time, because the cost impact of the rules regarding the netting of earnings of related foreign subsidiaries is subject to clarification. However, we have no current plans to repatriate such funds.

Given our current cash position, outlook for funds generated from operations, credit ratings, available credit facility, cash needs and debt structure, we have not experienced to date, and do not expect to experience, any material issues with liquidity, although we can give no assurances concerning our future liquidity, particularly in light of our current level of debt, U.S. Government budget uncertainties and the state of global commerce and financial uncertainty.

We also currently believe that existing cash, funds generated from operations, our credit facility and access to the public and private debt and equity markets will be sufficient to provide for our anticipated working capital requirements, capital expenditures, dividend payments, repurchases under our share repurchase program and repayments of our debt securities at maturity for the next 12 months and reasonably foreseeable future thereafter. Our total capital expenditures in fiscal 2019 are expected to be approximately $170 million. We anticipate tax payments in fiscal 2019 to be approximately equal to or marginally less than our tax expense for the same period, subject to adjustment for certain timing differences. For additional information regarding our income taxes, see Note 21: Income Taxes in the Notes. Other than those cash outlays noted in the “Contractual Obligations” discussion below in this MD&A (including repayment at maturity of the entire $300 million principal amount of our Floating Rate Notes due February 27, 2019), capital expenditures, dividend payments, repurchases under our share repurchase program and potential acquisitions, we do not anticipate any significant cash outlays in fiscal 2019.

There can be no assurance, however, that our business will continue to generate cash flows at current levels or that the cost or availability of future borrowings, if any, under our commercial paper program or our credit facility or in the debt markets will not be impacted by any potential future credit and capital markets disruptions. If we are unable to maintain cash balances or generate sufficient cash flow from operations to service our obligations, we may be required to sell assets, reduce capital expenditures, reduce or eliminate strategic acquisitions, reduce or terminate our share repurchases, reduce or eliminate dividends, refinance all or a portion of our existing debt or obtain additional financing. Our ability to make principal payments or pay interest on or refinance our indebtedness depends on our future performance and financial results, which, to a certain extent, are subject to general conditions in or affecting the defense, government and other markets we serve and to general economic, political, financial, competitive, legislative and regulatory factors beyond our control.

Net cash provided by operating activities: The $182 million increase in net cash provided by operating activities in fiscal 2018 compared with fiscal 2017 was primarily due to a $288 million decrease in cash used for qualified pension plan contributions, partially offset by a $102 million increase in cash used to fund working capital, net of lower cash paid for income taxes. The increase in cash used to fund working capital included $33 million associated with our discontinued operations that were included in the first three quarters of fiscal 2017.

The $355 million decrease in net cash provided by operating activities in fiscal 2017 compared with fiscal 2016 was primarily due to $415 million more in qualified pension plan contributions, including a $400 million voluntary contribution, and an increase in cash used in Exelis integration activities, partially offset by settlement of the Exelis excess pension plan in fiscal 2016 and an increase in cash provided by changes in working capital balances.

Cash flow from operations was positive in all of our business segments in fiscal 2018, 2017 and 2016.

Net cash provided by (used in) investing activities: The $141 million in net cash used in investing activities in fiscal 2018 compared with $870 million provided by investing activities in fiscal 2017 primarily reflected the absence in fiscal 2018 of any proceeds from sales of businesses, which totaled $1,014 million in fiscal 2017 (consisting of $646 million of net proceeds from the sale of IT Services and $368 million of net proceeds from the sale of CapRock).

The $870 million in net cash provided by investing activities in fiscal 2017 compared with $1 million used in investing activities in fiscal 2016 primarily reflected $833 million more in net proceeds from sales of businesses (consisting of $646 million of net proceeds from the sale of IT Services and $368 million of net proceeds from the sale of CapRock in fiscal 2017, compared with $181 million in net proceeds from the sale of Aerostructures in fiscal 2016), as well as $33 million less used for net additions of property, plant and equipment.

Net cash used in financing activities: The $633 million decrease in net cash used in financing activities in fiscal 2018 compared with fiscal 2017 was primarily due to $438 million less cash used to repurchase our common stock and $228 million less cash used for net repayment of borrowings (reflecting $271 million of cash used for net repayment of borrowings in fiscal 2018 compared with $499 million of cash used to repay borrowings in fiscal 2017).

The $545 million increase in net cash flows used in financing activities in fiscal 2017 compared with fiscal 2016 was primarily due to $710 million more cash used to repurchase our common stock, partially offset by $170 million less cash used for net repayment of borrowings (reflecting $499 million of cash used for net repayment of borrowings in fiscal 2017 compared with $669 million of cash used to repay borrowings in fiscal 2016).

Funding of Pension Plans

Funding requirements under applicable laws and regulations are a major consideration in making contributions to our U.S. pension plans. Although we have significant discretion in making voluntary contributions, the Employee Retirement Income Security Act of 1974, as amended by the Pension Protection Act of 2006 and further amended by the Worker, Retiree, and Employer Recovery Act of 2008, the Moving Ahead for Progress in the 21st Century Act (“MAP-21”) and applicable Internal Revenue Code regulations mandate minimum funding thresholds. Failure to satisfy the minimum funding thresholds could result in restrictions on our ability to amend the plan or make benefit payments. With respect to our U.S. qualified pension plans, we intend to contribute annually not less than the required minimum funding thresholds.

The Highway and Transportation Funding Act of 2014 (“HATFA”) and the Bipartisan Budget Act of 2015 further extended the interest rate stabilization provision of MAP-21 until 2020. We made voluntary contributions of $300 million and $400 million to our U.S. qualified pension plans during fiscal 2018 and 2017, respectively. As a result, we currently do not anticipate making any contributions to our U.S. qualified pension plans during fiscal 2019.

Future required contributions primarily will depend on the actual annual return on assets and the discount rate used to measure the benefit obligation at the end of each year. Depending on these factors, and the resulting funded status of our pension plans, the level of future statutory minimum contributions could be material. We had net unfunded defined benefit plan obligations of approximately $0.7 billion as of June 29, 2018 compared with approximately $1.3 billion as of June 30, 2017. See Note 13: Pension and Other Postretirement Benefits in the Notes for further information regarding our defined benefit plans.

Common Stock Repurchases

During fiscal 2018, we used $272 million to repurchase 1,959,435 shares of our common stock under our current repurchase program at an average price per share of $138.89, including commissions of $.02 per share. During fiscal 2017, we used $710 million to repurchase 6,637,239 shares of our common stock under our current and prior repurchase programs at an average price per share of $107.00, including (i) $350 million we paid on February 6, 2017 for 2,929,879 and 277,357 shares of our common stock received in the third and fourth quarters of fiscal 2017, respectively, under a fixed-dollar ASR transaction agreement we entered into February 6, 2017, (ii) $250 million we paid on May 5, 2017 for 1,931,818 and 296,952 shares of our common stock received in the fourth quarter of fiscal 2017 and the first quarter of fiscal 2018, respectively, under a fixed-dollar

ASR transaction agreement we entered into May 7, 2017, and (iii) approximately $110 million to repurchase an additional 1,201,233 shares of our common stock at an average price per share of $91.72, including commissions of $.02 per share. Pursuant to each of the fixed-dollar ASR transactions we entered into to repurchase an unspecified total number of shares of our common stock, the counterparty delivered to us shares of our common stock during the term of the transaction in exchange for an up-front fixed dollar payment. The specific total number of shares ultimately delivered, and therefore the average price paid per share, was determined at the end of the transaction based on the average of the daily volume-weighted average price per share of our common stock during the term of the transaction, less a discount. Shares delivered pursuant to ASR transactions were retired in the period of delivery, and the up-front payment was accounted for as a reduction to the “Other capital” and “Retained earnings” line items in our Consolidated Balance Sheet in the period the payment was made. In fiscal 2018 and fiscal 2017, $17 million and $21 million, respectively, in shares of our common stock were delivered to us or withheld by us to satisfy withholding taxes on employee share-based awards. Shares repurchased by us are cancelled and retired.

On January 26, 2017, our Board of Directors approved our current repurchase program, which is a $1 billion share repurchase program that does not have a stated expiration date and was in addition to our prior repurchase program, a $1 billion share repurchase program approved in 2013. Our repurchases during the fourth quarter of fiscal 2017 used the entire remaining authorization under our prior repurchase program. As of June 29, 2018, we had a remaining, unused authorization of approximately $701 million under our current repurchase program. Repurchases under our repurchase program are expected to be funded with available cash and commercial paper and may be made through open market purchases, private transactions, transactions structured through investment banking institutions or any combination thereof. The level of our repurchases depends on a number of factors, including our financial condition, capital requirements, cash flows, results of operations, future business prospects and other factors our Board of Directors may deem relevant. The timing, volume and nature of repurchases are subject to market conditions, applicable securities laws and other factors and are at our discretion and may be suspended or discontinued at any time. Additional information regarding our current repurchase program is set forth above under “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of this Report.

Dividends

On August 25, 2018, our Board of Directors increased the quarterly cash dividend rate on our common stock from $.57 per share to $.685 per share, for an annualized cash dividend rate of $2.74 per share, which was our seventeenth consecutive annual increase in our quarterly cash dividend rate. Our annualized cash dividend rate in fiscal 2018, 2017 and 2016 was $2.28 per share, $2.12 per share and $2.00 per share, respectively. There can be no assurances that our annualized cash dividend rate will continue to increase. Quarterly cash dividends are typically paid in March, June, September and December. We currently expect that cash dividends will continue to be paid in the near future, but we can give no assurances concerning payment of future dividends. The declaration of dividends and the amount thereof will depend on a number of factors, including our financial condition, capital requirements, cash flows, results of operations, future business prospects and other factors our Board of Directors may deem relevant. Additional information concerning our dividends is set forth above under “Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities” of this Report.

Capital Structure and Resources

2018 Credit Agreement: As discussed in Note 11: Credit Arrangements in the Notes, on June 26, 2018, we established a new $1 billion, 5-year senior unsecured revolving credit facility (the “2018 Credit Facility”) by entering into a Revolving Credit Agreement (the “2018 Credit Agreement”) with a syndicate of lenders. The 2018 Credit Facility replaced our prior $1 billion, 5-year senior unsecured revolving credit facility (the “2015 Credit Facility”). The description of the 2018 Credit Facility and the 2018 Credit Agreement set forth in Note 11: Credit Arrangements in the Notes is incorporated herein by reference.

Short-Term Debt: Our short-term debt at June 29, 2018 and June 30, 2017 was $78 million and $80 million, respectively, consisting of local borrowing by international subsidiaries for working capital needs and commercial paper. Our commercial paper program was supported by the 2018 Credit Facility at June 29, 2018 and by the 2015 Credit Facility at June 30, 2017.

Long-Term Variable-Rate Debt: The description of our long-term variable-rate debt set forth in Note 12: Debt in the Notes is incorporated herein by reference. As discussed in Note 12: Debt in the Notes, during the third quarter of fiscal 2018, we completed the issuance and sale of $300 million in aggregate principal amount of Floating Rate Notes due February 27, 2019 and used the proceeds to make a voluntary contribution to our U.S. qualified pension plans. During the second quarter of fiscal 2018, we completed the issuance and sale of $250 million in aggregate principal amount of Floating Rate Notes due April 30, 2020 and used the net proceeds, together with cash on hand, to repay in full the $253 million in remaining outstanding indebtedness under the 5-year tranche of our $1.3 billion senior unsecured term loan facility pursuant to our Term Loan Agreement, dated as of March 16, 2015. We repaid the entire $305 million in remaining outstanding indebtedness under our variable-rate term loans during fiscal 2018.

Long-Term Fixed-Rate Debt: The description of our long-term fixed-rate debt set forth in Note 12: Debt in the Notes is incorporated herein by reference. As discussed in Note 12: Debt in the Notes, on June 4, 2018, in order to fund our optional redemption of the Redeemed Notes described below, we completed the issuance and sale of $850 million in aggregate principal amount of 4.400% Notes due June 15, 2028. On June 22, 2018, we completed our optional redemption of the entire outstanding $400 million aggregate principal amount of our 4.4% Notes due December 15, 2020 (the “4.4% 2020 Notes”) and $400 million aggregate principal amount of our 5.55% Notes due October 1, 2021 (the “2021 Notes” and collectively with the 4.4% 2020 Notes, the “Redeemed Notes”) at a “make-whole” redemption price as set forth in the 4.4% 2020 Notes and the 2021 Notes, respectively. The combined “make-whole” redemption price for the Redeemed Notes was $844 million. The Redeemed Notes were terminated and cancelled. During the fourth quarter of fiscal 2018, we also repaid at maturity the entire outstanding $500 million aggregate principal amount of our 1.999% Notes due April 27, 2018.

During fiscal 2017, we repaid at maturity the entire outstanding $250 million aggregate principal amount of our 4.25% Notes due October 1, 2016.

Other Agreements: We have a receivable sales agreement (“RSA”) with a third-party financial institution that permits us to sell, on a non-recourse basis, up to $50 million of outstanding receivables at any given time. From time to time, we have sold certain customer receivables under the RSA, which we continue to service and collect on behalf of the third-party financial institution and which we account for as sales of receivables with sale proceeds included in net cash from operating activities. The impact to net cash from operating activities from these transactions was not material in fiscal 2018, 2017 or 2016.

Contractual Obligations

At June 29, 2018, we had contractual cash obligations to repay debt, to purchase goods and services and to make payments under operating leases. Payments due under these long-term obligations are as follows:



			Obligations Due by Fiscal Year

	Total		2019		2020 and 2021		2022 and 2023		After 2023

	(Dollars in millions)
Long-term debt	$	3,740	$	305	$	658	$	1	$	2,776
Purchase obligations (1)	1,224		932		259		32		1
Operating lease commitments	280		58		100		68		54
Interest on long-term debt	2,058		157		280		264		1,357
Minimum pension contributions (2)	1		1		—		—		—
Total contractual cash obligations (3)	$	7,303	$	1,453	$	1,297	$	365	$	4,188

(1) The purchase obligations of $1.2 billion included $127 million of purchase obligations related to cost-plus type contracts where our costs are fully reimbursable.

(2) Amount includes fiscal 2019 minimum contributions to a non-U.S. pension plan. Contributions beyond fiscal 2019 have not been determined. During fiscal 2018 and 2017, we made voluntary contributions of $700 million to our U.S. qualified pension plans, and as a result, we currently do not anticipate making any contributions to our U.S. qualified pension plans during fiscal 2019.

(3) The above table does not include unrecognized tax benefits of $102 million.

Off-Balance Sheet Arrangements

In accordance with the definition under SEC rules, any of the following qualify as off-balance sheet arrangements:


•	Any obligation under certain guarantee contracts;


•	A retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets;


•	Any obligation, including a contingent obligation, under certain derivative instruments; and


•	Any obligation, including a contingent obligation, under a material variable interest in an unconsolidated entity that is held by, and material to, the registrant, where such entity provides financing, liquidity, market risk or credit risk support to the registrant, or engages in leasing, hedging or R&D services with the registrant.

As of June 29, 2018, we were not participating in any material transactions that generated relationships with unconsolidated entities or financial partnerships, including variable interest entities, and we did not have any material retained or contingent interest in assets as defined above. As of June 29, 2018, we did not have material financial guarantees or other contractual commitments that are reasonably likely to adversely affect our financial condition, results of operations or cash flows, and we were not a party to any related party transactions that materially affect our financial condition, results of operations or cash flows.

We have, from time to time, divested certain of our businesses and assets. In connection with these divestitures, we often provide representations, warranties and/or indemnities to cover various risks and unknown liabilities, such as environmental liabilities and tax liabilities. We cannot estimate the potential liability from such representations, warranties and indemnities because they relate to unknown conditions. We do not believe, however, that the liabilities relating to these representations, warranties and indemnities will have a material adverse effect on our financial condition, results of operations or cash flows.

Due to our downsizing of certain operations pursuant to acquisitions, divestitures, restructuring plans or otherwise, certain properties leased by us have been sublet to third parties. If any of these third parties vacates any of these premises, we would be legally obligated under master lease arrangements. We believe that the financial risk of default by such sublessees is individually and in the aggregate not material to our financial condition, results of operations or cash flows.

Commercial Commitments

We have entered into commercial commitments in the normal course of business including surety bonds, standby letter of credit agreements and other arrangements with financial institutions and customers primarily relating to the guarantee of future performance on certain contracts to provide products and services to customers or to obtain insurance policies with our insurance carriers. At June 29, 2018, we had commercial commitments on outstanding surety bonds, standby letters of credit and other arrangements, as follows:



			Expiration of Commitments by Fiscal Year
	Total		2019		2020		2021		After 2021
	(Dollars in millions)
Surety bonds used for:
Bids	$	6	$	5	$	1	$	—	$	—
Performance	425		339		75		11		—
	431		344		76		11		—
Standby letters of credit used for:
Down payments	124		108		6		—		10
Performance	155		109		4		2		40
Warranty	18		16		1		—		1
	297		233		11		2		51
Total commitments	$	728	$	577	$	87	$	13	$	51

The surety bonds and standby letters of credit used for performance are primarily related to Public Safety and Professional Communications. As is customary in bidding for and completing network infrastructure projects for public safety systems, contractors are required to procure surety bonds and/or standby letters of credit for bids, performance, warranty and other purposes (collectively, “Performance Bonds”). Such Performance Bonds normally have maturities of up to three years and are standard in the industry as a way to provide customers a mechanism to seek redress if a contractor does not satisfy performance requirements under a contract. Typically, a customer is permitted to draw on a Performance Bond if we do not fulfill all terms of a project contract. In such an event, we would be obligated to reimburse the financial institution that issued the Performance Bond for the amounts paid. It has been rare for our Public Safety and Professional Communications business to have a Performance Bond drawn upon. In addition, pursuant to the terms under which we procure Performance Bonds, if our credit ratings are lowered to below “investment grade,” we may be required to provide collateral to support a portion of the outstanding amount of Performance Bonds. Such a downgrade could increase the cost of the issuance of Performance Bonds and could make it more difficult to procure Performance Bonds, which would adversely impact our ability to compete for contract awards. Such collateral requirements could also result in less liquidity for other operational needs or corporate purposes. In addition, any future disruptions, uncertainty or volatility in financial and insurance markets could also adversely affect our ability to obtain Performance Bonds and may result in higher funding costs.

Financial Risk Management

In the normal course of business, we are exposed to risks associated with foreign currency exchange rates and changes in interest rates. We employ established policies and procedures governing the use of financial instruments to manage our exposure to such risks.

Foreign Exchange and Currency: We use foreign currency forward contracts and options to hedge both balance sheet and off-balance sheet future foreign currency commitments. Factors that could impact the effectiveness of our hedging programs for foreign currency include accuracy of sales estimates, volatility of currency markets and the cost and availability of hedging instruments. A 10 percent change in currency exchange rates for our foreign currency derivatives held at June 29, 2018

would not have had a material impact on the fair value of such instruments or our results of operations or cash flows. This quantification of exposure to the market risk associated with foreign currency financial instruments does not take into account the offsetting impact of changes in the fair value of our foreign denominated assets, liabilities and firm commitments. See Note 18: Derivative Instruments and Hedging Activities in the Notes for additional information.

Interest Rates: As of June 29, 2018, we had long-term fixed-rate debt obligations. The fair value of these obligations is impacted by changes in interest rates; however, a 10 percent change in interest rates for our long-term fixed-rate debt obligations at June 29, 2018 would not have had a material impact on the fair value of these obligations. Additionally, there is no interest-rate risk associated with these obligations on our results of operations and cash flows, because the interest rates are fixed, and because our long-term fixed-rate debt is not putable to us (i.e., not required to be redeemed by us prior to maturity). We can give no assurances, however, that interest rates will not change significantly or have a material effect on the fair value of our long-term fixed-rate debt obligations over the next twelve months.

As of June 29, 2018, we also had long-term variable-rate debt obligations of $550 million, comprised of $250 million of Floating Rate Notes due April 30, 2020 and $300 million of Floating Rate Notes due February 27, 2019. These debt obligations bear interest that is variable based on certain short-term indices, thus exposing us to interest-rate risk; however, a 10 percent change in interest rates for these debt obligations at June 29, 2018 would not have had a material impact on our results of operations or cash flows. See Note 12: Debt in the Notes for further information.

As of June 29, 2018, we also had short-term variable-rate debt outstanding, primarily under our commercial paper program, subject to interest rate risk. We utilize our commercial paper program to satisfy short-term cash requirements, including bridge financing for strategic acquisitions until longer-term financing arrangements are put in place, temporarily funding repurchases under our share repurchase programs and temporarily funding redemption of long-term debt. The interest rate risk associated with such debt on our results of operations and cash flows is not material due to its temporary nature.

Impact of Foreign Exchange

Approximately 24 percent of our international business was transacted in local currency environments in fiscal 2018 compared with 20 percent in fiscal 2017. The impact of translating the assets and liabilities of these operations to U.S. dollars is included as a component of shareholders’ equity. As of June 29, 2018, the cumulative foreign currency translation adjustment included in shareholders’ equity was a $99 million loss compared with a $113 million loss at June 30, 2017. We utilize foreign currency hedging instruments to minimize the currency risk of international transactions. Gains and losses resulting from currency rate fluctuations did not have a material effect on our results in fiscal 2018, 2017 or 2016.

Impact of Inflation

To the extent feasible, we have consistently followed the practice of adjusting our prices to reflect the impact of inflation on salaries and fringe benefits for employees and the cost of purchased materials and services. Inflation and changing prices did not materially adversely impact our gross margin, revenue or operating income in fiscal 2018, 2017 or 2016.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The following is not intended to be a comprehensive list of our accounting policies or estimates. Our significant accounting policies are more fully described in Note 1: Significant Accounting Policies in the Notes. In preparing our financial statements and accounting for the underlying transactions and balances, we apply our accounting policies and estimates as disclosed in the Notes. We consider the policies and estimates discussed below as critical to an understanding of our financial statements because their application places the most significant demands on our judgment, with financial reporting results dependent on estimates about the effect of matters that are inherently uncertain and may change in subsequent periods. Specific risks for these critical accounting estimates are described in the following paragraphs. The impact and any associated risks related to these estimates on our business operations are discussed throughout this MD&A where such estimates affect our reported and expected financial results. Senior management has discussed the development and selection of the critical accounting policies and estimates and the related disclosure included herein with the Audit Committee of our Board of Directors. Preparation of this Report requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from those estimates.

Besides estimates that meet the “critical” accounting estimate criteria, we make many other accounting estimates in preparing our financial statements and related disclosures. All estimates, whether or not deemed “critical,” affect reported amounts of assets, liabilities, revenue and expenses as well as disclosures of contingent assets and liabilities. Estimates are based on experience and other information available prior to the issuance of the financial statements. Materially different results can occur as circumstances change and additional information becomes known, including for estimates that we do not deem “critical.”

Revenue Recognition

A significant portion of our business is derived from development and production contracts. Revenue and profits related to development and production contracts are recognized using the percentage-of-completion method, generally based on the ratio of costs incurred to estimated total costs at completion under the contract (i.e., the “cost-to-cost” method) with consideration given for risk of performance and estimated profit. The majority of the revenue in our Space and Intelligence Systems and Electronic Systems segments (and to a certain extent, revenue in our Communication Systems segment) relates to development and production contracts, and the percentage-of-completion method of revenue recognition is primarily used for these contracts. Change orders, claims or other items that may change the scope of a development and production contract are included in contract value only when the value can be reliably estimated and realization is probable. Possible incentives or penalties and award fees applicable to performance on development and production contracts are considered in estimating contract value and profit rates and are recorded when there is sufficient information to assess anticipated contract performance. Incentive provisions that increase earnings based solely on a single significant event generally are not recognized until the event occurs. We are party to certain contracts with incentive provisions or award fees that are subject to uncertainty until the conclusion of the contract, and our customers may be entitled to reclaim and receive previous award fee payments.

Under the percentage-of-completion method of accounting, a single estimated total profit margin is used to recognize profit for each development and production contract over its period of performance. Recognition of profit on development and production fixed-price contracts requires estimates of the total cost at completion and the measurement of progress toward completion. The estimated profit or loss on a development and production contract is equal to the difference between the estimated contract value and the estimated total cost at completion. Due to the long-term nature of many of our programs, developing the estimated total cost at completion often requires judgment. Factors that must be considered in estimating the cost of the work to be completed include the nature and complexity of the work to be performed, subcontractor performance, the risk and impact of delayed performance, availability and timing of funding from the customer and the recoverability of any claims outside the original development and production contract included in the estimate to complete. At the outset of each contract, we gauge its complexity and perceived risks and establish an estimated total cost at completion in line with these expectations. After establishing the estimated total cost at completion, we follow a standard estimate at completion process in which we review the progress and performance on our ongoing development and production contracts at least quarterly and, in many cases, more frequently. If we successfully retire risks associated with the technical, schedule and cost aspects of a contract, we may lower our estimated total cost at completion commensurate with the retirement of these risks. Conversely, if we are not successful in retiring these risks, we may increase our estimated total cost at completion. Additionally, at the outset of a cost-reimbursable contract (for example, contracts containing award or incentive fees), we establish an estimate of total contract value, or revenue, based on our expectation of performance on the contract. As the cost-reimbursable contract progresses, our estimates of total contract value may increase or decrease if, for example, we receive higher or lower than expected award fees. When adjustments in estimated total costs at completion or in estimated total contract value are determined, the related impact to operating income is recognized using the cumulative catch-up method, which recognizes in the current period the cumulative effect of such adjustments for all prior periods. Anticipated losses on development and production contracts or programs in progress are charged to operating income when identified. We have not made any material changes in the methodologies used to recognize revenue on development and production contracts or to estimate our costs related to development and production contracts in the past three fiscal years.

Estimate at completion adjustments had the following impacts to operating income for the periods presented:



	2018			2017			2016

	(In millions)
Favorable adjustments	$	127		$	118		$	187
Unfavorable adjustments	(125		)	(104		)	(119		)
Net operating income adjustments	$	2		$	14		$	68

There were no individual impacts to operating income due to estimate at completion adjustments in fiscal 2018, 2017 or 2016 that were material to our results of operations on a consolidated or segment basis for such periods.

We also recognize revenue from arrangements requiring the delivery or performance of multiple deliverables or elements under a bundled sale. In these arrangements, judgment is required to determine the appropriate accounting, including whether the individual deliverables represent separate units of accounting for revenue recognition purposes, and the timing of revenue recognition for each deliverable. If we determine that individual deliverables represent separate units of accounting, we recognize the revenue associated with each unit of accounting separately, and contract revenue is allocated among the separate units of accounting at the inception of the arrangement based on relative selling price. If options or change orders materially change the scope of work or price of the contract subsequent to inception, we reevaluate and adjust our prior conclusions regarding units of accounting and allocation of contract revenue as necessary. The allocation of selling price among the separate units of accounting may impact the timing of revenue recognition, but will not change the total revenue recognized on the

arrangement. We establish the selling price used for each deliverable based on the vendor-specific objective evidence (“VSOE”) of selling price, or third-party evidence (“TPE”) of selling price if VSOE of selling price is not available, or best estimate of selling price (“BESP”) if neither VSOE nor TPE of selling price is available. In determining VSOE of selling price, a substantial majority of the recent standalone sales of the deliverable must be priced within a relatively narrow range. In determining TPE of selling price, we evaluate competitor prices for similar deliverables when sold separately. Generally, comparable pricing of our products to those of our competitors with similar functionality cannot be obtained. In determining BESP, we consider both market data and entity-specific factors, including market conditions, the geographies in which our products are sold, our competitive position and strategy, and our profit objectives.

The FASB has issued a comprehensive new revenue recognition standard that supersedes nearly all existing revenue recognition guidance under GAAP, which is effective for us in fiscal 2019. See Note 2: Accounting Changes or Recent Accounting Pronouncements in the Notes for additional information.

Postretirement Benefit Plans

Former Exelis employees participate in numerous defined benefit pension and other postretirement defined benefit plans (collectively, referred to as “defined benefit plans”) in the United States, which are sponsored by Harris. The determination of projected benefit obligations and the recognition of expenses related to defined benefit pension plans are dependent on various assumptions. These major assumptions primarily relate to discount rates, long-term expected rates of return on plan assets, rate of future compensation increases, mortality, termination and other factors (some of which are disclosed in Note 13: Pension and Other Postretirement Benefits in the Notes). Actual results that differ from our assumptions are accumulated and generally amortized for each plan to the extent required over the estimated future life expectancy or, if applicable, the future working lifetime of the plan’s active participants.

Significant Assumptions

We develop assumptions using relevant experience, in conjunction with market-related data for each plan. Assumptions are reviewed annually with third party consultants and adjusted as appropriate. The table included below provides the weighted average assumptions used to estimate projected benefit obligations and net periodic benefit cost as they pertain to our defined benefit pension plans.



Obligation assumptions as of:	June 29, 2018	June 30, 2017
Discount rate	4.05%	3.76%
Rate of future compensation increase	2.76%	2.76%

Cost assumptions for fiscal years:	2018	2017
Discount rate to determine service cost	3.48%	3.80%
Discount rate to determine interest cost	3.28%	2.94%
Expected return on plan assets	7.66%	7.65%
Rate of future compensation increase	2.76%	2.75%

Key assumptions for the U.S. Salaried Retirement Plan (“U.S. SRP”) (our largest defined benefit plan, with approximately 90% of the total projected benefit obligation) included a discount rate for obligation assumptions of 4.07% and expected return on plan assets of 7.75% for fiscal 2018, which is being maintained at 7.75% for fiscal 2019. Effective December 31, 2016, accruals under the U.S. SRP benefit formula were frozen for all employees and replaced with a 1% cash balance benefit formula for certain employees who were not highly compensated on December 31, 2016.

Expected Return on Plan Assets

Substantially all of our plan assets are managed on a commingled basis in a master investment trust. We determine our expected return on plan assets by evaluating both historical returns and estimates of future returns. Specifically, we consider the plan’s actual historical annual return on assets over the past 15, 20 and 25 years and historical broad market returns over long-term time frames based on our strategic allocation, which is detailed in Note 13: Pension and Other Postretirement Benefits in the Notes. Future returns are based on independent estimates of long-term asset class returns. Based on this approach, the long-term annual rate of return on assets was estimated at 7.66% and 7.65% for fiscal 2018 and 2017, respectively.

Discount Rate

The discount rate is used to calculate the present value of expected future benefit payments at the measurement date. A decrease in the discount rate increases the present value of benefit obligations and generally decreases pension expense. The discount rate assumption is based on current investment yields of high-quality fixed income investments during the retirement benefits maturity period. The pension discount rate is determined by considering an interest rate yield curve comprising AAA/

AA bonds, with maturities between zero and thirty years, developed by the plan’s actuaries. Annual benefit payments are then discounted to present value using this yield curve to develop a single discount rate matching the plan’s characteristics.

In fiscal 2017, we changed the approach used to estimate the service and interest components of net periodic benefit cost of the U.S. defined benefit plans. The new estimation approach discounts the individual expected cash flows underlying the service cost and interest cost using the applicable spot rates derived from the yield curve used to discount the cash flows used to measure the benefit obligation. Prior to fiscal 2017, we estimated these service and interest cost components utilizing a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period.

We made this change to provide a more precise measurement of service and interest costs by improving the correlation between projected benefit cash flows and the corresponding spot yield curve rates. We accounted for this change as a change in accounting estimate and accordingly accounted for it prospectively. Although the benefit obligation measured under this approach was unchanged, the more granular application of the spot rates reduced the fiscal 2017 service and interest costs for the U.S. defined benefit plans by approximately $46 million as a result of this change.

Sensitivity Analysis

Pension Expense

A 25 basis point change in the long-term expected rate of return on plan assets and discount rate would have the following effect on the combined U.S. defined benefit pension plans’ fiscal 2019 pension expense:



	Increase/(Decrease) in Pension Expense
	25 Basis Point Increase			25 Basis Point Decrease

	(In millions)
Long-term rate of return on assets used to determine net periodic benefit cost	$	(12.3	)	$	12.2
Discount rate used to determine net periodic benefit cost	$	7.4		$	(7.8	)

Projected Benefit Obligation

Funded status is derived by subtracting the respective year-end values of the projected benefit obligations (“PBO”) from the fair value of plan assets. The sensitivity of the PBO to changes in the discount rate varies depending on the magnitude and direction of the change in the discount rate. We estimate that a decrease of 25 basis points in the discount rate of the combined U.S. defined benefit pension plans would increase the PBO by approximately $150 million and an increase of 25 basis points would decrease the PBO by approximately $144 million.

Fair Value of Plan Assets

The plan assets of our defined benefit plans comprise a broad range of investments, including domestic and international equity securities, fixed income investments, interests in private equity and hedge funds and cash and cash equivalents.

A portion of our defined benefit plans asset portfolio is comprised of investments in private equity and hedge funds. The private equity and hedge fund investments are generally measured using the valuation of the underlying investments or at net asset value. However, in certain instances, the values reported by the asset managers were not current at the measurement date. Consequently, we have estimated adjustments to the last reported value where necessary to measure the assets at fair value at the measurement date. These adjustments consider information received from the asset managers, as well as general market information. Asset values for other positions were generally measured using market observable prices. See Note 13: Pension and Other Postretirement Benefits in the Notes for further information.

Provisions for Excess and Obsolete Inventory Losses

We value our inventory at the lower of cost or net realizable value. We balance the need to maintain prudent inventory levels to ensure competitive delivery performance with the risk of excess or obsolete inventory due to changing technology and customer requirements. We regularly review inventory quantities on hand and record a provision for excess and obsolete inventory primarily based on our estimated forecast of product demand, anticipated end of product life and production requirements. The review of excess and obsolete inventory applies to all of our business segments. Several factors may influence the sale and use of our inventories, including our decision to exit a product line, technological change and new product development. These factors could result in a change in the amount of obsolete inventory quantities on hand. Additionally, our estimates of future product demand may prove to be inaccurate, in which case we may have understated or overstated the provision required for excess and obsolete inventory. In the future, if we determine that our inventory is overvalued, we would be required to recognize such costs in the “Cost of product sales” line item in our Consolidated Statement of Income at the time of such determination. In the case of goods that have been written down below cost, such reduced amount is to be considered the cost for subsequent accounting purposes. We have not made any material changes in the reserve methodology used to establish our inventory loss reserves during the past three fiscal years.

As of June 29, 2018, our reserve for excess and obsolete inventory was $66 million, or 14 percent of our gross inventory balance, which compares with our reserve of $52 million, or 12 percent of our gross inventory balance, as of June 30, 2017. Although we make reasonable efforts to ensure the accuracy of our forecasts of future product demand, including the impact of planned future product launches, any significant unanticipated changes in demand or technological developments could have a significant impact on the value of our inventory and our reported operating results.

Goodwill

Goodwill in our Consolidated Balance Sheet as of June 29, 2018 and June 30, 2017 was $5,372 million and $5,366 million, respectively. Goodwill is not amortized. We perform annual (or under certain circumstances, more frequent) impairment tests of our goodwill. We identify potential impairment by comparing the fair value of each of our reporting units with its carrying amount, including goodwill, which is adjusted for allocations of corporate assets and liabilities as appropriate. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not impaired. If the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized in an amount equal to that excess.

IT Services Goodwill Allocation and Impairment

As described in more detail in Note 3: Discontinued Operations and Divestitures in the Notes, we entered into a definitive agreement to sell IT Services on January 26, 2017 and completed the sale on April 28, 2017.

Because the then-pending divestiture of IT Services represented the disposal of a portion of a reporting unit within our former Critical Networks segment, we assigned $487 million of goodwill to the IT Services disposal group on a relative fair value basis during the third quarter of fiscal 2017, when the held for sale criteria were met. The fair value of the IT Services disposal group was determined based on the negotiated selling price, and the fair value of the retained businesses (which comprised the remaining portion of the reporting unit) was determined based on a combination of market-based valuation techniques, utilizing quoted market prices and comparable publicly reported transactions, and projected discounted cash flows. These fair value determinations are categorized as Level 3 in the fair value hierarchy due to their use of internal projections and unobservable measurement inputs.

In conjunction with the relative fair value allocation, we tested goodwill assigned to the disposal group and goodwill assigned to the retained businesses for impairment. As a result, we concluded, in connection with the preparation of our financial statements for the third quarter of fiscal 2017, that goodwill and other assets related to IT Services were impaired as of March 31, 2017, and we recorded a non-cash impairment charge of $240 million in discontinued operations, $228 million of which related to goodwill. The goodwill impairment charge was non-deductible for tax purposes.

Fiscal 2016, 2017 and 2018 Impairment Tests

We estimate fair values of our reporting units based on projected cash flows, and sales and/or earnings multiples applied to the latest twelve months’ sales and earnings of our reporting units. Projected cash flows are based on our best estimate of future sales, operating costs and balance sheet metrics reflecting our view of the financial and market conditions of the underlying business; and the resulting cash flows are discounted using an appropriate discount rate that reflects the risk in the forecasted cash flows. The sales and earnings multiples applied to the sales and earnings of our reporting units are based on current multiples of sales and earnings for similar businesses, and based on sales and earnings multiples paid for recent acquisitions of similar businesses made in the marketplace. We then assess whether any implied control premium, based on a comparison of fair value based purely on our stock price and outstanding shares with fair value determined by using all of the above-described models, is reasonable. We have not made any material changes during the past three fiscal years in the methodology used in the assessment of whether or not goodwill is impaired.

In the fourth quarter of fiscal 2016, 2017 and 2018, we performed our annual impairment tests of our reporting units’ goodwill. We completed these tests with no adjustment required to the goodwill of any of our reporting units. As of the date of our fiscal 2018 impairment test, the estimated fair value for each of our reporting units exceeded its carrying amount.

Income Taxes and Tax Valuation Allowances

We record the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in our Consolidated Balance Sheet, as well as operating loss and tax credit carryforwards. We follow very specific and detailed guidelines in each tax jurisdiction regarding the recoverability of any tax assets recorded on the balance sheet and provide necessary valuation allowances as required. Future realization of deferred tax assets ultimately depends on the existence of sufficient taxable income of the appropriate character (for example, ordinary income or capital gain) within the carryback or carryforward periods available under the tax law. We regularly review our deferred tax assets for recoverability based on historical taxable income, projected future taxable income, the expected timing of the reversals of existing temporary differences and tax planning strategies. We have not made any material changes in the methodologies used to determine our tax valuation allowances during the past three fiscal years.

Our Consolidated Balance Sheet as of June 29, 2018 included deferred tax assets of $116 million and deferred tax liabilities of $90 million. This compares with deferred tax assets of $409 million and deferred tax liabilities of $34 million as of

June 30, 2017. For all jurisdictions for which we have net deferred tax assets, we expect that our existing levels of pre-tax earnings are sufficient to generate the amount of future taxable income needed to realize these tax assets. Our valuation allowance related to deferred income taxes, which is reflected in our Consolidated Balance Sheet, was $181 million as of June 29, 2018 and $183 million as of June 30, 2017. Although we make reasonable efforts to ensure the accuracy of our deferred tax assets, if we continue to operate at a loss in certain jurisdictions or are unable to generate sufficient future taxable income, or if there is a material change in the actual effective tax rates or time period within which the underlying temporary differences become taxable or deductible, or if the potential impact of tax planning strategies changes, we could be required to increase the valuation allowance against all or a significant portion of our deferred tax assets resulting in a substantial increase in our effective tax rate and a material adverse impact on our operating results.

Impact of Recently Issued Accounting Pronouncements

Accounting pronouncements that have recently been issued but have not yet been implemented by us are described in Note 2: Accounting Changes or Recent Accounting Pronouncements in the Notes, which describes the potential impact that these pronouncements are expected to have on our financial condition, results of operations and cash flows.

FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT FUTURE RESULTS

The following are some of the factors we believe could cause our actual results to differ materially from our historical results or our current expectations or projections. Other factors besides those listed here also could adversely affect us. See “Item 1A. Risk Factors” of this Report for more information regarding factors that might cause our results to differ materially from those expressed in or implied by the forward-looking statements contained in this Report.


•	We depend on U.S. Government customers for a significant portion of our revenue, and the loss of these relationships, a reduction in U.S. Government funding or a change in U.S. Government spending priorities could have an adverse impact on our business, financial condition, results of operations and cash flows.


•	We depend significantly on U.S. Government contracts, which often are only partially funded, subject to immediate termination, and heavily regulated and audited. The termination or failure to fund, or negative audit findings for, one or more of these contracts could have an adverse impact on our business, financial condition, results of operations and cash flows.


•	We could be negatively impacted by a security breach, through cyber attack, cyber intrusion, insider threats or otherwise, or other significant disruption of our IT networks and related systems or of those we operate for certain of our customers.

•

The U.S. Government’s budget deficit, the national debt and sequestration, as well as any inability of the U.S. Government to complete its budget process for any government fiscal year and consequently having to operate on funding levels equivalent to its prior fiscal year pursuant to a “continuing resolution” or shut down, could have an adverse impact on our business, financial condition, results of operations and cash flows.


•	The level of returns on defined benefit plan assets, changes in interest rates and other factors could affect our financial condition, results of operations and cash flows in future periods.


•	We enter into fixed-price contracts that could subject us to losses in the event of cost overruns or a significant increase in inflation.


•	We use estimates in accounting for many of our programs, and changes in our estimates could adversely affect our future financial results.


•	We derive a significant portion of our revenue from international operations and are subject to the risks of doing business internationally, including fluctuations in currency exchange rates.


•	Our reputation and ability to do business may be impacted by the improper conduct of our employees, agents or business partners.


•	We may not be successful in obtaining the necessary export licenses to conduct certain operations abroad, and Congress may prevent proposed sales to certain foreign governments.


•	Our future success will depend on our ability to develop new products, systems, services and technologies that achieve market acceptance in our current and future markets.


•	We participate in markets that are often subject to uncertain economic conditions, which makes it difficult to estimate growth in our markets and, as a result, future income and expenditures.


•	We cannot predict the consequences of future geo-political events, but they may adversely affect the markets in which we operate, our ability to insure against risks, our operations or our profitability.


•	Strategic transactions, including acquisitions and divestitures, involve significant risks and uncertainties that could adversely affect our business, financial condition, results of operations and cash flows.


•	Disputes with our subcontractors or the inability of our subcontractors to perform, or our key suppliers to timely deliver our components, parts or services, could cause our products, systems or services to be produced or delivered in an untimely or unsatisfactory manner.


•	Third parties have claimed in the past and may claim in the future that we are infringing directly or indirectly upon their intellectual property rights, and third parties may infringe upon our intellectual property rights.


•	The outcome of litigation or arbitration in which we are involved from time to time is unpredictable, and an adverse decision in any such matter could have a material adverse effect on our financial condition, results of operations and cash flows.


•	We face certain significant risk exposures and potential liabilities that may not be covered adequately by insurance or indemnity.


•	Changes in our effective tax rate may have an adverse effect on our results of operations.


•	Our level of indebtedness and our ability to make payments on or service our indebtedness and our unfunded defined benefit plans liability may adversely affect our financial and operating activities or our ability to incur additional debt.


•	A downgrade in our credit ratings could materially adversely affect our business.


•	Unforeseen environmental issues could have a material adverse effect on our business, financial condition, results of operations and cash flows.


•	We have significant operations in locations that could be materially and adversely impacted in the event of a natural disaster or other significant disruption.


•	Changes in future business or other market conditions could cause business investments and/or recorded goodwill or other long-term assets to become impaired, resulting in substantial losses and write-downs that would adversely affect our results of operations.


•	Some of our workforce is represented by labor unions, so our business could be harmed in the event of a prolonged work stoppage.


•	We must attract and retain key employees, and any failure to do so could seriously harm us.

Previous: Item 6. SELECTED FINANCIAL DATA. · Next: Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.