(In millions, except per share amounts, unless otherwise stated)

You should read the following discussion of our results of operations and financial condition together with the audited Consolidated and Combined Financial Statements and the notes thereto as well as the discussion in the section of this Annual Report on Form 10-K entitled "Description of Business." This discussion contains forward-looking statements that involve risks and uncertainties. The forward-looking statements are not historical facts, but rather are based on current expectations, estimates, assumptions and projections about our industry, business and future financial results. Our actual results could differ materially from the results contemplated by these forward-looking statements due to a number of factors, including those discussed in the sections of this Annual Report on Form 10-K entitled "Risk Factors" and "Cautionary Statement Concerning Forward-looking Statements."

OVERVIEW

Exelis is a leader in Command, Control, Communications, Computers, Intelligence, Surveillance and Reconnaissance (C4ISR) related products and systems and information and technical services, which it supplies to military, government and commercial customers in the United States and globally. Exelis provides mission-critical systems in the areas of networked communications, sensing and surveillance, electronic warfare, navigation, air traffic solutions and information systems, with growing positions in cyber-security, composite aerostructures, logistics and technical services. The Company's customers include the United States (U.S.) Department of Defense (DoD), including the U.S. Army, Navy, Marines and Air Force, and its prime contractors, U.S. Government intelligence agencies, National Aeronautics and Space Administration (NASA), Federal Aviation Administration (FAA), allied foreign governments and domestic and foreign commercial customers. As a prime contractor, subcontractor, or preferred supplier, Exelis participates in many high priority defense and non-defense programs in the United States. Exelis conducts most of its business with the U.S. Government, principally the DoD. Exelis Inc. was incorporated in Indiana on May 4, 2011.

Our business is reported in two segments: Command, Control, Communications, Computing, Intelligence, Surveillance and Reconnaissance ("C4ISR") Electronics and Systems, and Information and Technical Services. Our C4ISR Electronics and Systems segment provides engineered electronic systems and equipment, including force protection, electronic warfare systems, reconnaissance and surveillance systems, and integrated structures. Our Information and Technical Services segment is a provider of logistics, infrastructure, and sustainment support, while also providing a diverse set of technical services.

Separation from ITT Corporation

On January 12, 2011, ITT Corporation ("ITT") announced a plan to separate its Defense and Information Solutions (Exelis) segment from the remainder of its businesses through a pro rata distribution of common stock of an entity holding the assets and liabilities associated with the Defense and Information Solutions segment. We were incorporated in Indiana on May 4, 2011 to be the entity to hold such businesses. The Spin-off from ITT was completed on October 31, 2011 (the "Distribution Date"), and Exelis became an independent publicly traded company. In connection with the Spin-off, the common stock of Exelis was distributed, on a pro rata basis, to ITT's shareholders of record as of the close of business on October 17, 2011 (the "Record Date"). On the Distribution Date, each of the shareholders of ITT received one share of Exelis common stock for every one share of common stock of ITT held on the Record Date. On October 31, 2011, ITT also completed its spin-off of

Xylem Inc., which includes ITT's water-related businesses. The Spin-off was completed pursuant to the Distribution Agreement, dated as of October 25, 2011, among ITT, Exelis and Xylem Inc. After the Distribution Date, ITT did not beneficially own any shares of Exelis common stock.

Prior to the Spin-off, we were a business segment of ITT Corporation. The financial information included herein may not necessarily reflect our financial position, results of operations and cash flows in the future or what our financial position, result of operations and cash flows would have been had we been an independent, publicly traded company during the periods presented prior to October 31, 2011. We have been incurring additional costs necessary to operate as an independent, publicly traded company, including additional costs related to corporate finance, governance and public reporting. We have funded these costs through cash on hand and cash from operations, and we believe cash flows from operations will be sufficient to fund these additional costs going forward.

We believe that the Spin-off has allowed us, and will continue to allow us, to improve strategic planning, increase management focus and streamline decision-making by providing us the flexibility to implement our unique strategic plans and to respond more effectively to our customer needs and the changing economic environment.

Known Trends and Uncertainties

Economic Opportunities, Challenges, and Risks

The United States continues to face significant economic and fiscal challenges, including slow GDP growth, high unemployment, and persistent U.S. federal government budget deficits. Concerns over fiscal deficits and the national debt continue to drive the political debate and no national consensus exists on the appropriate level of defense and other federal spending, making longer-term funding targets and priorities unclear.

This fiscal uncertainty has not abated following the U.S. Presidential election in November 2012, and significant ambiguity persists as Congress and the Presidential Administration negotiate actions to address budget deficits and overall federal spending. We believe the prospects for finalizing fiscal year 2013 spending levels remain low because Congress has failed to pass either a fiscal year 2013 budget resolution or the individual appropriations bills that serve to allocate discretionary spending among the federal government's cabinet agencies, commissions, boards and independent agencies. For the near term, Congress has enacted a six month continuing resolution (CR), which will keep the government operating through March 27, 2013.

The CR assumes a top line discretionary spending amount of $1.05 trillion for fiscal year 2013, consistent with the Comprehensive Budget Agreement (CBA) of August 2011, which translates into an expected spending level of $608 billion for the DoD, down from $634 billion in fiscal year 2012, driven in large part by declining Overseas Contingency Operation (OCO) funding of $89 billion, down from about $115 billion in fiscal year 2012. The CBA also includes a provision known as "Sequestration," scheduled to be implemented in March 2013, which would impose significantly greater cuts to DoD budgets over the next ten years, unless a compromise solution to reduce budget deficits is reached by Congress and the President. If Sequestration were implemented it would significantly reduce most defense and domestic discretionary spending by fixed percentages of approximately 9% and 8%, respectively. Although the precise outcome is unclear, we expect increased uncertainty and lower top-line DoD spending over the next several years. Cuts could significantly reduce spending on procurement and research and development, accelerate reductions in force structure, and drive further savings in operations and maintenance and overhead spending.

We believe potential solutions to this budgetary uncertainty include the following: a yearlong CR with no enacted fiscal year 2013 appropriations bills or budget resolutions; a short term one year spending reduction bill which temporarily delays the first year of sequestration; or a comprehensive multi-year budget agreement which combines spending cuts, tax reform, and entitlement or mandatory spending formula changes. Companies which derive substantial revenues from federal contracting will benefit the most from a comprehensive agreement which implements fundamental multi-year changes that would prevent Sequestration from actually occurring. The debate over how and when a solution may be reached over the as-yet unresolved sequestration issue remains a significant issue for the defense industry.

In its last strategic guidance, the DoD emphasized a shift to a leaner force that is agile, flexible and technologically advanced. This shift in force structure focuses on addressing a range of continuously evolving threats including terrorism, state aggression, weapons of mass destruction and cyberspace-related aggression. Geographically, the DoD recognizes the growing importance of the Pacific Rim regarding U.S. economic and security interests. As a result, the DoD is emphasizing the intent to build upon its Asia-Pacific presence while maintaining commitments in the Middle East and Europe, and at the same time increasing reliance on allied partnerships. We believe ongoing instability in the Middle East will result in continued U.S. involvement in the region however, making a full and complete "pivot" to Asia-Pacific less attainable. We believe our portfolio of defense solutions, which covers a broad range of differentiated products and services, aligns well with the priorities outlined in the DoD's guidance. However, uncertainty related to potential changes in final appropriations and strategic priorities could materially impact our business.

Programs related specifically to the support of ongoing operations in Afghanistan are subject to changes in the level of U.S. commitment. The current Presidential Administration has stated its intent to withdraw all major forces by 2014 and maintain a limited presence after the subsequent transition to the Afghan government.

The DoD is focused on several initiatives to improve efficiency, refocus priorities, and enhance DoD business practices. As part of these initiatives, the DoD is re-evaluating the way capabilities are procured and continues to experiment with novel approaches. This acquisition reform could increase competitive pressures and impact defense industry sales levels and profit margins going forward. We believe, however, that we are well positioned for this environment by offering affordable and ready-now solutions, which may realize true cost savings for the DoD.

It is expected that as large-scale ground deployments continue to decline, less emphasis will be placed on capabilities required for U.S. soldiers (Soldier Systems), including counter-IED jammers, night vision equipment and tactical communications systems. These expectations are reflected in our business plans. While it is evident that reductions in demand for Soldier Systems will occur, the specific end state remains uncertain.

We believe that spending on recapitalization, modernization and maintenance of defense and security assets will continue despite possible reductions to some defense programs in which we participate or for which we expect to compete. We expect ongoing DoD emphasis to be placed on our areas of strength, such as electronic warfare, intelligence, surveillance and reconnaissance (ISR), imagery payloads, precision navigation instruments, cyber solutions, and information processing, exploitation and dissemination.

Although the federal government faces budget pressures and constraints for the foreseeable future, we believe that we are well positioned in areas of persistent demand in certain civil agencies, including our development and operation of the FAA's ADS-B system, and management and operation of NASA's space communications networks.

Globally, continued fiscal pressures in overseas economies could impact our business in markets such as the United Kingdom and continental Europe. However, we are forecasting continued market growth in the Middle East and Asia-Pacific regions with new opportunities to expand our international business.

The information provided above represents a list of known trends and uncertainties that could impact our business in the foreseeable future. It should, however, be considered along with the risk factors identified under the caption "Risk Factors" and the discussion under the section "Cautionary Statement Concerning Forward-Looking Statements" in this Annual Report on Form 10-K.

Executive Summary

Exelis reported revenue of $5.5 billion for the year ended December 31, 2012, a decrease of approximately 5% compared to 2011. The decrease in revenue was driven by revenue declines of 12% within our C4ISR Electronics and Systems segment primarily due to lower demand for surge-related products, including our Night Vision and Single Channel Ground and Airborne Radio Systems (SINCGARS) products. Revenue increased less than 1% within our Information and Technical Services segment, primarily due to efforts to support the U.S. Armed services under our Afghanistan programs and efforts to support NASA under our Space Communication Network Services (SCNS) contract.

Operating income for the year ended December 31, 2012 was $561, reflecting an increase of $26 or 5% compared to 2011. Overall, operating margin increased year-over-year to 10.2% from 9.2%. The increase in operating income and operating margin was primarily due to lower selling, general and administrative and research and development expenses.

Additional Company highlights for the year ended December 31, 2012 included the following:

• We completed our first full year as an independent, publicly traded company.

• We declared four quarterly cash dividends totaling $79 or $0.41 per share.

• We generated cash from operating activities of $385, a year-over-year increase of 15%.

• We reported net income of $330, an increase of 1% from 2011.

Key Performance Indicators and Non-GAAP Measures

Management reviews key performance indicators including revenue, segment operating income and margins, orders growth, and backlog, among other metrics on a regular basis. In addition, we consider certain additional measures to be useful to management and investors evaluating our operating performance for the periods presented, and provide a tool for evaluating our ongoing operations, liquidity and management of assets. This information can assist investors in assessing our financial performance and measures our ability to generate capital for deployment among competing strategic alternatives and initiatives, including, but not limited to, acquisitions and debt repayment. These metrics, however, are not measures of financial performance under accounting principles generally accepted in the United States of America (GAAP) and should not be considered a substitute

for revenue, operating income, income from continuing operations, or net cash from continuing operations as determined in accordance with GAAP. We consider the following non-GAAP measure, which may not be comparable to similarly titled measures reported by other companies, to be a key performance indicator:

• "Adjusted income from continuing operations" defined as income from continuing operations, adjusted to exclude items that include, but are not limited to, significant charges or credits that impact current results, but are not related to our ongoing operations, unusual and infrequent non-operating items and non-operating tax settlements or adjustments. A reconciliation of adjusted income from continuing operations is provided below.

                                                              Year Ended December 31,
                                                         2012            2011           2010
Income from continuing operations                     $      330      $      326      $    448
Separation costs, net of tax                                  19              29             -
Tax-related special items                                      -              16             -
Adjusted income from continuing operations                   349             371           448
Income from continuing operations per diluted
share                                                 $     1.75      $     1.75      $   2.39
Adjusted income from continuing operations per
diluted share                                         $     1.85      $     1.99      $   2.39

DISCUSSION OF FINANCIAL RESULTS

YEAR ENDED DECEMBER 31, 2012 COMPARED TO YEAR ENDED DECEMBER 31, 2011



                                                   Year Ended December 31,
                                             2012           2011           Change
     Product and service revenue           $   5,522      $   5,839            (5.4 )%
     Cost of product and service revenue       4,359          4,616            (5.6 )%
     Operating expense                           602            688           (12.5 )%
     Operating income                            561            535             4.9 %
     Operating margin                           10.2 %          9.2 %
     Interest expense, net                        37             10             270 %
     Other expense (income), net                   3            (12 )           125 %
     Income tax expense                          191            211            (9.5 )%
     Effective income tax rate                  36.7 %         39.3 %
     Net Income                            $     330      $     326             1.2 %

Revenue

Revenue for the year ended December 31, 2012 was $5,522, reflecting a decrease
of $317 or 5.4% as compared to 2011. The decline in revenue in our C4ISR
Electronics and Systems segment was slightly offset by revenue growth in our
Information and Technical Services segment. The following table illustrates
revenue for our segments for the years ended December 31, 2012 and 2011:



                                                 Year Ended December 31,
                                            2012          2011          Change
       C4ISR Electronics and Systems      $   2,487     $   2,817          (11.7 )%
       Information & Technical Services       3,035         3,022            0.4 %
       Total revenue                      $   5,522     $   5,839           (5.4 )%

Revenue from our C4ISR Electronics and Systems segment was $2,487 in 2012, a decline of $330 or 11.7% as compared to 2011. The decrease in revenue was primarily due to volume declines in surge-related products, including Night Vision products of approximately $175, SINCGARS products of approximately $173, and Counter RCIED Electronic Warfare (CREW) 2.1 and special purpose jammer products of approximately $36. The decrease in revenue was partially offset by higher revenue from the sales of our Band C Upgrade kits for legacy CREW products of approximately $82 and our other counter-IED systems of approximately $24.

Revenue from our Information and Technical Services segment was $3,035 in 2012, an increase of $13 or 0.4% as compared to 2011. The increase in revenue was primarily due to efforts to support the U.S. Armed services on our Afghanistan Programs, including the Afghan National Security Forces (ANSF) Facilities Support programs and the Logistics Civilian Augmentation Program (LOGCAP), which had revenue increases of approximately $63 and $38, respectively, and efforts to support NASA under our Space Communication Network Services (SCNS) contract, which had a revenue increase of approximately $47. The SCNS contract provides the communications and tracking services for a wide range of Earth-orbiting spacecraft, including the International Space Station. The increase in revenue was partially offset by lower revenue on our Technology and Systems Engineering Bridge (TSE Bridge) program of approximately $65, and lower activity on our Kuwait based Army Proposition Stock-5 (APS-5 Kuwait) contract of approximately $45. The TSE Bridge program, part of our Advanced Information Systems business, ended in late 2011.

Cost of Revenue and Operating Expenses

Cost of product and service revenue and other operating expenses are comprised
of the following:



                                                              Year Ended December 31,
                                                      2012             2011             Change
Cost of product revenue                             $   1,726        $   1,933             (10.7 )%
% of product revenue                                     69.4 %           68.6 %
Cost of service revenue                                 2,633            2,683              (1.9 )%
% of service revenue                                     86.8 %           88.8 %
Selling, general and administrative expenses              516              566              (8.8 )%
% of total revenue                                        9.3 %            9.7 %
Research and development expenses                          67               99             (32.3 )%
% of total revenue                                        1.2 %            1.7 %
Restructuring and asset impairment charges, net            19               23             (17.4 )%
% of total revenue                                        0.3 %            0.4 %

Cost of Product and Service Revenue

The decrease in cost of product revenue of $207 or 10.7% in 2012 as compared to 2011 was primarily due to lower sales in our C4ISR Electronics and Systems segment. The cost of product revenue as a percent of product revenue increased primarily due to a net sales mix of lower margin products.

The decrease in cost of services revenue of $50 or 1.9% in 2012 as compared to 2011 was primarily due to productivity improvements in our Information and Technical Services segment. The cost of service revenue as a percent of service revenue decreased primarily due to productivity improvements and contract pricing adjustments on several contracts in our Air Traffic Management and Afghanistan Program areas.

Selling, General & Administrative Expenses (SG&A)

SG&A expenses as a percent of total revenue was 9.3% in 2012, compared to 9.7% in 2011. The decrease in SG&A expenses as a percent of total revenue was due to lower SG&A expenses partially offset by lower revenue. SG&A expenses decreased primarily due to the absence of general corporate expense allocations from ITT of $102 and cost reductions partially resulting from prior year restructuring in our C4ISR Electronics and Systems segment, partially offset by higher general corporate expenses necessary to operate as a stand-alone company. The corporate expense allocations received from ITT during 2011 included allocations for defined benefit pension and other postretirement defined benefit plan costs of $79.

Research and Development Expenses (R&D)

The decrease in R&D expenses of $32 or 32.3% in 2012 as compared to 2011 primarily reflects the completion of certain R&D projects for integrated electronic warfare systems, other communication technologies and night vision technologies primarily within our C4ISR Electronics and Systems segment.

Restructuring and Asset Impairment Charges, Net

We recognized net restructuring and asset impairment charges of $19 in 2012, compared to $23 in 2011. The decrease in net restructuring and asset impairment charges primarily represent lower severance costs, partially offset by higher asset impairment changes, in our C4ISR Electronics and Systems segment. Restructuring charges in 2012 and 2011 primarily represent severance costs in our C4ISR Electronics and Systems segment to better align our headcount with reduced production volume on Night Vision, SINCGARS and CREW products.

Operating Income

The following table illustrates the 2012 and 2011 operating income results of
our business segments, including operating margin results:



                                                  Year Ended December 31,
                                              2012         2011         Change
          C4ISR Electronics & Systems        $   350      $   385        (9.1)%
          Operating margin                      14.1 %       13.7 %
          Information & Technical Services       211          150        40.7%
          Operating margin                       7.0 %        5.0 %
          Total operating income             $   561      $   535          4.9%
          Total operating margin                10.2 %        9.2 %

Operating income at our C4ISR Electronics and Systems segment decreased $35 or 9.1% in 2012, compared to 2011. Operating income as a percentage of revenue was 14.1% in 2012 as compared to 13.7% in 2011. The increase in operating margin was primarily due to lower R&D and SG&A expenses as a percentage of product revenue, partially offset by higher cost of product revenue as a percentage of product revenue.

Operating income at our Information and Technical Services segment increased $61 or 40.7% in 2012, compared to 2011. Operating income as a percentage of revenue was 7.0% in 2012 as compared to 5.0% in 2011. The increase in operating margin was primarily due to lower cost of service revenue as a percentage of service revenue.

During the performance of long-term sale contracts, estimated final contract prices and costs are reviewed periodically and revisions are made as required and recorded in income in the period in which they are determined. Changes in estimated revenues, cost of revenue and the related effect to operating income are recognized using a cumulative catch-up adjustment which recognizes in the current period the cumulative effect of the changes on current and prior periods based on a contract's percent complete. Net favorable cumulative catch-up adjustments related to prior periods increased operating income by approximately $65 and $143 for the years ended December 31, 2012 and 2011, respectively. Productivity improvements and contract pricing adjustments primarily contributed to the net favorable cumulative catch-up adjustments in the current year.

Impact to Operating Income from Defined Benefit Plan Expense

We recorded net periodic benefit costs of $43 in 2012, compared to $46 in 2011. In 2011, prior to the Spin-off, we also received intercompany expense allocations from ITT for defined benefit pension plan and other postretirement defined benefit plan costs of $79.

Total defined benefit plan costs, including both net periodic benefit costs and . . .