Lockheed Martin 2001 Annual Report Download - page 21

Lockheed Martin Corporation
December 31, 2001
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
In September 1999, the Corporation sold its interest in
Airport Group International Holdings, LLC which resulted in
a nonrecurring and unusual gain, net of state income taxes,
of $33 million. In October 1999, the Corporation exited its
commercial 3D graphics business through a series of trans-
actions which resulted in the sale of its interest in Real 3D,
Inc., a majority-owned subsidiary, and a nonrecurring and
unusual gain, net of state income taxes, of $33 million. On
a combined basis, these transactions increased 1999 net
earnings by $43 million ($0.11 per diluted share).
Results of Operations
A significant portion of the Corporation’s business is
derived from long-term development and production contracts
which are accounted for under the provisions of the American
Institute of Certified Public Accountants’ (AICPA) audit and
accounting guide, “Audits of Federal Government Con-
tractors,” and the AICPA’s Statement of Position No. 81-1,
“Accounting for Performance of Construction-Type and
Certain Production-Type Contracts.” The nature of these
contracts and the types of products and services provided
are considered in determining the proper accounting for a
given contract. Generally, long-term fixed-price contracts
are recorded on a percentage of completion basis using
units of delivery as the measurement basis for progress
toward completion and revenue recognition; however, cer-
tain other long-term fixed-price contracts which, among
other things, provide for the delivery of minimal quantities
over a longer period of time, or require a significant amount
of development effort in relation to total contract value, are
recorded upon achievement of performance milestones or
using the cost-to-cost method of accounting where revenue
is recognized based on the ratio of costs incurred to
estimated total costs at completion. Sales under cost-
reimbursement-type contracts are recorded as costs are
incurred. As a general rule, sales and profits are recog-
nized earlier in a production cycle under the cost-to-cost
and milestone methods of percentage of completion
accounting. The Corporation has accounting policies in
place to address the complexities involved in accounting
for long-term contracts. For additional information on criti-
cal accounting policies in place for recognizing sales and
profits, see the discussion under the caption “Sales and
earnings” in “Note 1—Significant Accounting Policies.”
Contract accounting requires significant judgment rela-
tive to assessing risks, estimating contract costs and making
related assumptions for schedule and technical issues. Due
to the size and nature of many of the Corporation’s con-
tracts, the estimation of cost at completion is complicated
and subject to numerous variables. Contract costs include
material, labor and subcontracting costs, as well as an allo-
cation of indirect costs. Assumptions must be made relative
to the length of time to complete the contract, as estimated
costs also include anticipated increases in wages and
prices for materials. With respect to contract change
orders, claims or similar items, judgment must be used in
estimating related amounts and assessing the potential for
realization. Such amounts are only included in contract
value when they can be reliably estimated and realization
is probable. Incentives or penalties and awards applicable
to performance on contracts are considered in estimating
sales and profit rates, and are recorded when there is suffi-
cient information to assess anticipated performance.
Goods and services provided under long-term develop-
ment and production contracts represent a significant por-
tion of the Corporation’s business, and therefore amounts
recorded in its consolidated financial statements using con-
tract accounting methodologies and cost accounting stan-
dards are material. U.S. Government procurement standards
are followed relative to assessing the allowability as well as
the allocability of costs. Given the significance of the judg-
ments and estimation processes described above, it is likely
that materially different amounts could be recorded if differ-
ent assumptions were used or if underlying circumstances
were to change. The Corporation closely monitors compliance
and consistency of application of its critical accounting poli-
cies related to contract accounting. Reviews of the status of
contracts are performed by business segment personnel
through periodic contract status and performance reviews.
When adjustments in contract value or estimated costs are
determined, any changes from prior estimates are generally
reflected in earnings in the current period. In addition, reg-
ular and recurring evaluations of contract cost, scheduling
and technical matters are performed by management per-
sonnel who are independent from the business area per-
forming under the contract. Costs incurred and allocated to
contracts with the U.S. Government are closely scrutinized
for compliance with underlying regulatory standards by
Lockheed Martin personnel, and are subject to audit by
the Defense Contract Audit Agency.
Since the Corporation’s operating cycle is long-term
and involves many types of development and production
contracts with varying production delivery schedules, the
results of operations of a particular year, or year-to-year
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