Lockheed Martin 2013 Annual Report Download - page 43

This approach for negotiating contracts with our U.S. Government customers generally allows for the recovery of our costs.
We also may enter into long-term supply contracts for certain materials or components to coincide with the production
schedule of certain products and to ensure their availability at known unit prices.
Many of our contracts span several years and include highly complex technical requirements. At the outset of a contract,
we identify and monitor risks to the achievement of the technical, schedule, and cost aspects of the contract, and assess the
effects of those risks on our estimates of total costs to complete the contract. The estimates consider the technical
requirements (e.g., a newly-developed product versus a mature product), the schedule and associated tasks (e.g., the number
and type of milestone events), and costs (e.g., material, labor, subcontractor and overhead). The initial profit booking rate of
each contract considers risks surrounding the ability to achieve the technical requirements, schedule, and costs in the initial
estimated costs at completion. Profit booking rates may increase during the performance of the contract if we successfully
retire risks surrounding the technical, schedule and cost aspects of the contract. Conversely, our profit booking rates may
decrease if the estimated costs to complete the contract increase. All of the estimates are subject to change during the
performance of the contract and may affect the profit booking rate.
We have a number of programs that are designated as classified by the U.S. Government which cannot be specifically
described. The operating results of these classified programs are included in our consolidated and business segment results,
and are subjected to the same oversight and internal controls as our other programs.
Our net sales are primarily derived from long-term contracts for products and services provided to the U.S. Government
as well as FMS contracted through the U.S. Government. We account for these contracts, as well as product contracts with
non-U.S. Government customers, using the percentage-of-completion method of accounting, which represent substantially all
of our net sales. We derive our remaining net sales from contracts to provide services to non-U.S. Government customers,
which we account for under the services method of accounting.
Under the percentage-of-completion method of accounting, we record sales on contracts based upon our progress
towards completion on a particular contract as well as our estimate of the profit to be earned at completion. Cost-
reimbursable contracts provide for the payment of allowable costs plus a fee. For fixed-priced contracts, net sales and cost of
sales are recognized as products are delivered or as costs are incurred. Due to the nature of the percentage-of-completion
method of accounting, changes in our cost of sales are typically accompanied by a related change in our net sales.
In the discussion of comparative segment results, changes in net sales and operating profit generally are expressed in
terms of volume. Changes in volume refer to increases or decreases in sales resulting from varying production activity levels,
deliveries, or service levels on individual contracts. Volume changes typically include a corresponding change in segment
operating profit based on the current profit booking rate for a particular contract.
In addition, comparability of our sales, segment operating profit, and segment operating margins may be impacted by
changes in profit booking rates on our contracts accounted for using the percentage-of-completion method of accounting.
Increases in the profit booking rates, typically referred to as risk retirements, usually relate to revisions in the total estimated
costs at completion that reflect improved conditions on a particular contract. Conversely, conditions on a particular contract
may deteriorate resulting in an increase in the estimated costs at completion and a reduction of the profit booking rate.
Increases or decreases in profit booking rates are recognized in the current period and reflect the inception-to-date effect of
such changes. Segment operating profit and segment operating margins may also be impacted, favorably or unfavorably, by
other matters such as the resolution of contractual matters; restructuring charges, except for significant severance actions as
mentioned above; cost recoveries on all restructuring charges; reserves for disputes; asset impairments; and insurance
recoveries; among others. Segment operating profit and items such as risk retirements, reductions of profit booking rates, or
other matters are presented net of state income taxes.
Our consolidated net adjustments not related to volume, including net profit booking rate adjustments and other matters,
increased segment operating profit, net of state income taxes, by approximately $2.1 billion, $1.9 billion, and $1.6 billion for
2013, 2012, and 2011. The increase in our consolidated net adjustments for 2013 as compared to 2012 primarily was due to
an increase in profit booking rate adjustments at our MST and MFC business segments and, to a lesser extent, the increase in
the favorable resolution of contractual matters for the corporation. The increase in our consolidated net adjustments for 2012
as compared to 2011 primarily was due to an increase in profit booking rate adjustments and the favorable resolution of
contractual matters at our MST and MFC business segments. The consolidated net adjustments for 2013 and 2012 are
inclusive of approximately $600 million and $500 million in unfavorable items, which include a significant profit reduction
on the F-35 development contract in both years, as well as a significant profit reduction on the C-5 program in 2013, each as
described in our Aeronautics business segment’s results of operations discussion below. Unfavorable items in 2012 were
about $100 million higher than 2011, primarily due to a significant profit reduction on the F-35 development contract in 2012
as mentioned above.
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