Lockheed Martin 2010 Annual Report Download - page 21

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Other contracts in backlog are for the transition from development to production (e.g., Low Rate Initial Production), which
includes the challenge of starting and stabilizing a manufacturing production and test line while the final design is being validated.
These generally are cost-reimbursable or fixed-price incentive contracts, although there is a current stated U.S. Government
preference for fixed-price incentive contracts. Under a fixed-price incentive contract, the allowable costs incurred are eligible for
reimbursement, but are subject to a cost-share limit which affects profitability. If our costs exceed the contract target cost or are not
allowable under the applicable regulations, we may not be able to obtain reimbursement for all costs and may have our fees reduced or
eliminated.
There are also contracts for production as well as operations and maintenance of the delivered products that have the challenge
of achieving a stable production and delivery rate, while maintaining operability of the product after delivery. These contracts are
mainly fixed-price, although some operations and maintenance contracts are time and materials-type. Under fixed-price contracts, we
receive a fixed price despite the actual costs we incur. We have to absorb any costs in excess of the fixed price. Under time-and-
materials contracts, we are paid for labor at negotiated hourly billing rates and for certain expenses.
The failure to perform to customer expectations and contract requirements may result in reduced fees and affect our financial
performance in that period. Under each type of contract, if we are unable to control costs, our operating results could be adversely
affected, particularly if we are unable to justify an increase in contract value to our customers. Cost overruns or the failure to perform
on existing programs also may adversely affect our ability to retain existing programs and win future contract awards.
If our subcontractors, suppliers, or teaming agreement or joint venture partners fail to perform their obligations, our
performance and our ability to win future business could be harmed.
Many of our contracts involve subcontracts or teaming arrangements with other companies upon which we rely to perform a
portion of the services that we must provide to our customers. We also sometimes bid for and contract work through joint ventures,
rather than through subcontract or teaming arrangements. There is a risk that we may have disputes with our subcontractors,
teammates, or venture members, including disputes regarding the quality and timeliness of work performed, the workshare provided to
that party, customer concerns about the other party’s performance, our failure to extend existing task orders or issue new task orders,
or our hiring of the personnel of a subcontractor, teammate, or venture member, or vice versa. In addition, the contracting parties on
which we rely may be affected by changes in the economic environment and constraints on available financing to meet their
performance requirements or provide needed supplies on a timely basis. A failure by one or more of those contracting parties to
provide the agreed-upon supplies or perform the agreed-upon services on a timely basis may affect our ability to perform our
obligations. Contracting party performance deficiencies may affect our operating results and could result in a customer terminating our
contract for default. A default termination could expose us to liability and affect our ability to compete for future contracts and orders.
The funding and costs associated with our pension and postretirement medical plans may temporarily impact our cash flow
and cause our earnings and stockholders’ equity to fluctuate significantly from year to year.
A substantial portion of our current and retired employee population is covered by pension and postretirement medical
plans. The amount that we are required to fund and the costs of these plans are dependent upon various factors, including the actual
market rate of return on plan assets, discount rates, plan participant population demographics, and future legislative and government
regulatory requirements. Changes in these factors affect our plan funding, cash flow, and earnings. For more information on how these
factors could impact earnings and stockholders’ equity, see “Critical Accounting Policies – Postretirement Benefit Plans” in
Management Discussion and Analysis of Financial Conditions and Results of Operations beginning on page 43 of this Form 10-K.
We generally are able to recover these costs as allowable costs on our U.S. Government contracts, but there are delays between
when we contribute cash to the plans and recover it under government cost accounting rules. The Pension Protection Act required the
Cost Accounting Standards (CAS) Board to modify its pension accounting rules to better align the recovery of pension contributions
on U.S. Government contracts with the new accelerated funding required by the Act. The CAS Board has proposed changes to its
pension accounting rules, but final rules are not expected to be effective until after 2011.
In recent years, we have taken certain actions to mitigate the effect of our defined benefit pension plans on our financial results,
including no longer offering a defined benefit pension plan to new, non-represented employees, and making substantial discretionary
cash contributions to the existing plans to improve their funded status. In 2010, we contributed $2.2 billion to our defined benefit
pension plans.
If we fail to manage acquisitions, divestitures, and other transactions successfully, our financial results, business, and future
prospects could be harmed.
In pursuing our business strategy, we routinely conduct discussions, evaluate targets, and enter into agreements regarding
possible acquisitions, divestitures, joint ventures, and equity investments. As part of our business strategy, we seek to identify
acquisition or investment opportunities that will expand or complement our existing products and services, or customer base, at
attractive valuations. We often compete with others for the same opportunities. To be successful, we must conduct due diligence to
identify valuation issues and potential loss contingencies, negotiate transaction terms, complete and close complex transactions, and